Rolls-Royce (LSE: RR) has been losing altitude rapidly. The Rolls-Royce share price is down over 20% since its November high, at the time of writing this article yesterday. Over the past year, the shares have only added 2% compared to the 11% gain of the FTSE 100 index as a whole. Having missed out on an earlier Rolls-Royce rally, should I act on this latest fall be a buying opportunity for my portfolio?
Short-term reasons for the fall
Why has the Rolls share price gone into a tailspin again?
The answer is not only predictable – it was predicted. As I wrote last month when considering whether the Rolls-Royce share price could reach £2, “Further lockdowns in some markets could also reduce demand, hurting revenues and profits”. In recent weeks, pandemic fears have seen lockdowns and restrictions in multiple markets. The impact has been a drop in travel bookings.
As Ryanair’s chief executive noted, “Travel only exists on a degree of confidence”. Like other airlines, Ryanair’s bookings have fallen. Investors worry about what that means for Rolls-Royce due to its large business manufacturing and servicing aircraft engines.
Long-term reasons for optimism
Set against that, I do still see a number of reasons to be bullish about the Rolls-Royce share price.
The company has a large installed base of engines which need to be serviced. While demand for flying remains subdued, it is still higher than during the depths of the pandemic. The company said last week that its large engine flying hours are currently around 50% of their pre-pandemic level. Some airlines have recently placed large orders for new aircraft, suggesting confidence for high future demand. That should help boost revenues and profits at Rolls-Royce, one of only a handful of large aircraft engine makers.
On top of that, the company’s businesses in space and defence have proven to be fairly resilient even during the pandemic. I expect that to continue being the case, with much of this business relying on multiyear contracts with good future visibility.
The company turned free cash flow positive in its third quarter. It previously guided the market to expect that it would turn free cash flow positive in the second half. While the latest news means that technically it has hit that goal, I will be watching to see whether it continues to be free cash flow positive from now onwards. That matters because if the company has more cash coming in than going out, its liquidity will improve. That reduces the risk that it will need to tap shareholders for more cash in a dilutive rights issue, as it did last year. There is a risk that further lockdowns could lead to the company bleeding cash again.
My next move on the Rolls-Royce share price
I think the underlying case for Rolls-Royce remains decent.
I don’t think the possible demand fall caused by pandemic concerns is unexpected, which is why I flagged it last month. But the price fall means that the Rolls-Royce share price looks more attractive to me. I am also cheered by the news that the company has turned free cash flow positive. I would consider adding it to my portfolio on that basis.
