Rolls-Royce (LSE: RR) has been one of the most bought stocks on the Hargreaves Lansdown investment platform this year. It seems as if investors are rushing to snap up shares in the aerospace business as they trade at one of their lowest levels in recent history.
The stock plunged at the beginning of the year when it became clear the pandemic would have a significant impact on air travel around the world. However, in the weeks and months since, the company’s outlook has improved. Management has strengthened the balance sheet through a multi-billion pound fundraising and slashed operating costs.
As the state of the global aviation market has started to thaw, Rolls-Royce’s sales have also begun to increase. Although the improvement hasn’t been as good as management initially expected.
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Still, the company is heading in the right direction. I believe that bodes well for its share price in 2021.
Rolls-Royce shares on offer?
Rolls-Royce operates a relatively unique business model. The bulk of its income comes not from engine sales but engine maintenance contracts. The company doesn’t make any money on each engine it sells to customers. It makes money on the service contracts afterwards. The value of these service contracts is based on the number of hours flown by each engine. Therefore, the more flight time an aircraft can complete, the higher the revenues are for Rolls-Royce.
As such, when the global aviation industry froze earlier this year, Rolls’ revenues plunged. Luckily, the market has since started to recover. In its latest trading update, Rolls declared that flying hours for the year to the beginning of November were around 42% of 2019 levels. That’s still a significant year-on-year drop, but the figures are heading in the right direction.
Based on these trends, the company now expects to return to a favourable free cash flow position by the end of 2021. If it can do this, I think Rolls-Royce is a good investment proposition at current levels.
One of the reasons why the stock has fallen so heavily this year is the fact the market is concerned about group solvency. Indeed, management is projecting a total cash outflow of more than £4bn this year. However, if Rolls-Royce can return to a positive cash flow position, this cloud should lift. That would be hugely positive for the shares, in my opinion.
Improving outlook
Considering all of the above, I think it might be worth taking a closer look at Rolls-Royce. The company may be an attractive investment for 2021 if it can stop the bleed. Management believes this is possible, and I think they’re right, especially considering the improving outlook for the aerospace industry.
Therefore, I believe investors may benefit from buying Rolls-Royce as the company moves from its recovery to growth stage over the next few years.
