At the beginning of 2020, the Rolls-Royce (LSE: RR) share price changed hands for around 232p. But then the coronavirus pandemic struck.
As the aviation industry around the world was grounded, the firm had to fight for its survival. Investors, fearing the worst, fled, and the value of the company’s shares plunged.
By the beginning of October 2020, the Rolls-Royce share price had fallen below 40p, a decline of 84% from the year-end 2019 level.
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Over the past 12 months, the stock has regained some of its losses. The stock is up around 8% over the past year.
And now the aviation industry is starting the claw back its pandemic losses, the outlook for the Rolls-Royce share price is beginning to improve.
I think there’s even a chance the stock could return to 200p at some point in the future.
Rolls-Royce share price outlook
Over the past year, the pandemic has forced Rolls to take defensive action. It has reduced activity and slashed thousands of jobs.
The company is a much smaller enterprise today than it was two years ago. This suggests the value of the business has been permanently impaired. Unfortunately, that implies the stock may never return to pre-2019 levels, although this is only a rough guide. It’s impossible to say what the future holds for any stock price.
That’s not to say the Rolls-Royce share price can’t return to 200p. Back in 2019, the stock was changing hands for around 300p. I think it’s unlikely it’ll return to this level anytime soon.
However, management is targeting free cash flow of around £750m in the next two years. If the company can hit this target, it would be trading at a free cash flow yield of about 9%. Peers in the aerospace and defence sector are trading at a free cash flow yield of around 3-5%.
These metrics imply the stock could be worth almost double its current valuation if it hits its free cash flow target.
That is a big IF. The third wave of coronavirus has already disrupted the company’s cash flow target. Another coronavirus wave, or an engineering setback, could blow up these projections.
On a knife-edge
As such, it seems to me as if the stock is on a bit of a knife-edge. It needs everything to go right over the next few years and win more business to hit its growth targets.
If growth doesn’t live up to expectations, investor sentiment may take a hit as the company disappoints yet again.
Based on these takeaways, I’d be happy to buy the stock for my portfolio as a speculative investment. I think it could be incredibly undervalued if everything goes right over the next two to three years. I believe it could get closer to its former heights.
Nevertheless, it’s clear this isn’t an investment for the faint-hearted. Any number of other things could go wrong that would cause additional problems across the group.
