The top reason for the Rolls-Royce (LSE: RR) share price drop in 2020 was the coronavirus, of course. It follows that if 2021 is better from the pandemic standpoint, the worst must really be over for the company.
I’d like to believe that as much as anyone else. The current decline of the 114-year-old and highly regarded British brand makes me cringe. At the same time, I just can’t help but take a really good look at the situation it’s in.
Risks to the Rolls-Royce share price
I see at least three big risks to the Rolls-Royce share price:
#1. The pandemic’s far from over: The coronavirus’s new strain could do more than just put a dampener on London’s holiday season. It may render the vaccine ineffective, sending us straight back to square one. Eventually, it may not turnout as bad as that, but the risk needs to be acknowledged. For suppliers to aviation, like Rolls-Royce, this isn’t good news.
#2. Financials are discouraging: Even if we assume for a minute that we will in fact put Covid-19 behind us in 2021, I’m concerned about RR’s financials. This year has weakened them, but its income was on shaky grounds even before the outbreak. In three of the last five years (2015–19) it showed a net loss.
With air travel expected to return to 2019 levels only in the next couple of years (if that), I reckon the spillover effect continue to be felt by RR. I think we can assume that it could be a decade in total before its earnings steady themselves.
#3. Share price is still weak: I think that investors understand the risks to holding Rolls-Royce shares quite well. Which is probably why even the rise in share price is quite muted.
Moreover, as per Financial Times data, analysts’ average forecast for the RR share price in the next 12 months is 12% lower than its current levels. In other words, analysts actually expect it to fall further from here in 2021.
And this answers the question in the headline — the worst probably isn’t over for the Rolls Royce share price!
The takeaway
Let me put this in some context. According to Goldman Sachs, the FTSE 100 index is expected to rise 14% in the next year. This means that roughly speaking the average FTSE 100 company’s share price is expected to rise by that much. In fact, there will be a number of them that will rise even faster to make up for the drag expected from the likes of Rolls-Royce.
Why then would I buy RR right now, when I have a full year to assess its progress and potentially buy it at a lower price than it’s at today?
I’d be much better off buying promising FTSE 100 shares that will give me more predictable returns over time.
