A core expertise of aeronautical engineer Rolls-Royce (LSE: RR) is gaining altitude fast. In the past few years though, that was not something associated with the Rolls-Royce share price. The shares have halved in value over the past five years.
Recently, things have been looking up. The shares are up 58% over the past 12 months. In just a couple of weeks at the end of last month and start of March, they gained 47%. Since then however, the Rolls-Royce share price looks like it has been taking a breather.
Can it continue its upward ascent, or has the recent rally fizzled out?
Positive momentum
The main reason for the uptick in the Rolls-Royce share price was the release of last year’s results, alongside the unveiling of a programme designed to improve the long-term profitability of the engineer.
But I think those have now been factored into the share price. After all, on a statutory basis, the company made a £1.5bn loss last year. Rolls-Royce has net debt of £3.3bn. The market capitalisation of £12bn therefore does not look cheap to me. I think investors are pricing in the prospects of improving business momentum and more attractive future business economics.
At this point though, I think it is time for the firm to show not tell. Rolls-Royce now has to grow into its expanded valuation. For it to move higher still, I think we need to see a sharply improved commercial performance. That will likely take months, if not years, to materialise.
What comes next
The business certainly could improve its performance. Rolls-Royce has the wind in its sails at the moment. Global civil aviation demand has bounced back strongly, demand from defence clients is set to grow and the company’s programme to improve profitability could see cost-cutting that boosts margins. Its strong brand and large installed base of aircraft engines are a valuable competitive differentiator.
But there are execution risks. Aviation demand remains fragile and could be hurt by soaring ticket prices at a time when many households are cutting their leisure spending. Business aviation demand remains lower than before the pandemic and I think a rise in online meetings means some business travel has gone away forever.
My move
The sharp move upwards in the Rolls-Royce share price meant the stake I bought when the shares sold for pennies each showed a handsome profit.
I was tempted to hold the shares for longer, as I think that they could move up further if the coming year starts to show some early fruits from the transformation programme.
But I see risks and feel that the current price is already fairly generous, given that Rolls-Royce just reported a sizeable loss and the impact of its cost-cutting programme remains unclear. It may improve margins, but also damage employee morale or customer confidence. In the long term, either of those things could be bad for the company.
I like the business and would be happy to buy in again in future at an attractive price. For now, I suspect the Rolls-Royce share price may have levelled off after its steep rise. In any case, I see the valuation as a little demanding. I therefore took advantage of it recently to sell my stake at a profit.
