The Rolls-Royce Holdings (LSE: RR) share price has been grounded over the last year. As I write, the aero engine firm’s shares have risen by just 5% since June 2020. That leaves them well behind the 15% gain delivered by the FTSE 100 over the same period.
I reckon investors have put Rolls in a holding pattern while they wait to see when air travel will really get started again. But with travel restrictions now being lifted more widely, will July be the month when the market takes a fresh look at Rolls-Royce shares?
What do we know already?
The last trading update from Rolls-Royce came in May. CEO Warren East said that flying hours during the first four months of 2021 were 60% below 2019 levels. This was pretty much as expected. Flying on long-haul routes has been supported by cargo demand and airlines preserving their airport slots by flying near-empty planes.
East said that vaccination progress in the US and UK was “encouraging” but admitted the timing of a wider recovery was still “uncertain”.
Rolls-Royce’s other business units were said to be performing as expected, with defence especially strong.
A turning point?
Rolls-Royce expects to start generating free cash flow “at some point during the second half of 2021.” When this happens will depend on how quickly engine flying hours recover, driving up billable revenue.
I reckon this could be a key turning point for the Rolls-Royce share price. Free cash flow is essential to Rolls’ recovery. Without this, the group can’t start to repay debt.
More widely, I think investors may be waiting to see if East can deliver on his free cash flow forecasts. Even before the pandemic, these targets were a key part of his turnaround strategy.
The next trading update from Rolls-Royce is due on 5 August. I’ll be watching closely for any changes to the company’s forecasts.
Rolls-Royce share price: up in July?
At about 108p, Rolls-Royce stock has already risen by 170% from the lows of 40p seen when the company launched a £5bn refinancing last October. After such strong gains, is a recovery already priced into the shares?
I estimate that Rolls-Royce’s current valuation is about 20% below the level seen at the end of 2019, including debt. If profits return to pre-pandemic levels, I can see some room for further share price gains.
Broker forecasts also seem quite encouraging to me. Consensus forecasts for 2022 price Rolls’ stock on 25 times earnings. This multiple falls to 15 times earnings for 2023, when profits are expected to rise above 2019 levels.
If international travel really takes off in July, then I think we could see Rolls-Royce’s share price move higher next month.
However, I think a fair level of recovery is already priced into the stock. Any disappointments could cause the price to slump again. For this reason, I won’t be buying Rolls-Royce shares at current levels. I don’t think the potential rewards are big enough to outweigh the risks.
