Many shareholders in Rolls-Royce (LSE: RR) have been preparing for take-off in recent months. The Rolls-Royce share price is down 11% over the past year. But it has returned an impressive 165% since the start of October. So for some shareholders, the price movements have been very profitable.
Here I take a look at both bull and bear cases for Rolls-Royce. I then consider whether the Rolls-Royce share price could rise to 150p this year.
A Rolls-Royce bull case
The company is one of the world’s leading manufacturers and maintenance providers for aircraft engines. This is a highly skilled industry with high capital expenditure requirements and lead times stretching into years or even decades. That means the competitive barriers to entry are high.
The Rolls-Royce brand name and engineering expertise are well-regarded. This helps give it pricing power. It also builds customer loyalty. That could help the Rolls-Royce share price because the majority of the company’s profits are generated not by engine sales but servicing.
In 2019, for example, the company sold £3.2bn of civil aircraft engines. But it recorded a further £4.9bn in service revenues for the sector. Even with flying hours reduced by the pandemic, 2020 service revenues came in at £2.8bn.
Not just civil aviation
Additionally, there is more to Rolls-Royce than just civil aviation. Defence spending tends to be more resilient than consumer travel. Last year, the company’s defence business actually grew underlying revenue by 4% to £3.4bn. It also grew underlying operating profit by 8%, to £448m.
The company also has a power systems division. While its revenue and profit also suffered last year, at least it is not also tied to consumer travel demand. Defence and power systems provided 51% of company revenue in 2020. Unlike civil aviation, both turned in an underlying operating profit.
With liquidity of £9bn coming into 2021, the company looks able to wait for a full recovery in demand. This month it reiterated its expectation that it would turn cash flow positive in the second half of this year. That appeals to me because I like buying shares in cash generative companies.
A bear case on the Rolls-Royce share price
Set against this, demand for flying is coming back slower than hoped. Limited vaccination programmes and ongoing lockdowns in many countries are stymying travel.
In October Rolls-Royce had said it expected 2021 widebody flying hours to be around 70% of 2019 levels, but it has since reduced that forecast to 55%. Less flying hours means less service revenue. The reduced forecast may push back the date when the company can achieve its free cash flow target of at least £750m.
The company has been seeking to improve liquidity further through cost cuts and disposals. But this week it was announced that the Norwegian government has stopped the sale of its power business in Norway. The company still plans to raise at least £2bn from disposals by early 2022. But this may now require a different approach.
I think the shares can reach 150p
The Rolls-Royce share price has performed strongly in the past few months. I think further good news, such as more flying hours being logged, could help propel the shares higher, maybe to 150p in 2021.
But key factors – such as demand – remain outside the company’s control. I would prefer to invest in a company with a clearer short-term demand outlook. I’m still not buying Rolls-Royce.
