Is reopening important for the Rolls-Royce share price?

As the economy reopens, could a return to flying be good news for the Rolls-Royce share price? Christopher Ruane considers the engine maker’s prospects.

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The Rolls-Royce (LSE: RR) share price has returned over 175% since October. But over the past 12 months, it has fallen 6%. Does the recent Rolls-Royce share price increase suggest that investors feel a reopened economy means better times for the aerospace giant?

I’ll consider what reopening means in practice for Rolls-Royce and its share price.

The core business model

The company’s business model is based around selling and servicing engines. The long tail servicing of engines is where aircraft engine makers typically make the bulk of their profits. That’s why part of Rolls-Royce’s strategy has been to “capture throughlife value of in-service products”.

Take 2019 as an example. That year, unaffected by the pandemic, services accounted for 52% of revenue.

With demand currently reduced, engine orders may be delayed or cancelled. Some airlines may decide to reduce their future fleet, or use the environment to drive a hard bargain on engine costs. None of that is good for the Rolls-Royce share price, in my view. However, that is a longer-term concern. I see the more pressing issue as servicing.

Aircraft engine are scheduled for different levels of maintenance based on how many hours they fly. Reduced flight time means a longer gap between servicing.

Demand outlook

The company currently expects large engine flying hours to return to 55% of 2019 levels this year, with a stronger recovery in the second half compensating for a weaker start to the year. By next year, the company foresees recovery to 80% of 2019 levels, reduced from an earlier estimate of 90%.

Even with the 55% figure this year, the company expects to turn cash flow positive in the second half as recovery quickens.

However, its annual free cash flow target of £750m is based on a recovery to 80% of 2019 demand. The company expects that to happen in 2022. However, as its previous forecast revisions have illustrated, demand visibility remains unclear for now.

Reopening and the Rolls-Royce share price

Reopening could bring an increase in demand for flying. On a positive analysis, the pent up demand for travel combined with a high consumer savings rate in many locked down markets might actually herald a travel boom.

On a more bearish analysis, however, reopening might not presage a return to 2019 flying levels. Some passengers will be warier of travelling, while others may opt for domestic holidays. I also doubt business travel will recover to 2019 levels any time soon, as many companies have switched to remote working.

Not just about flying hours

While civil aviation flying hours are important to Rolls-Royce, its business does have segments that I see as more defensive. For example, its power business and military aviation businesses have not seen the demand slowdown the civil aerospace business has.

Last year, the civil aerospace segment was only 44% of company revenues, so the relative resilience of the other business segments is a significant point to note. Meanwhile, reopening is progressing in many markets and flying is back. US daily passenger numbers have now reached 60% of 2019 levels, for example.

I think these other businesses and an upturn in flying hours bodes well for the Rolls-Royce share price. Nonetheless, global reopening and a widescale return to flying seem necessary to me for the company to recover fully. The timing of both remains unclear. I am not buying Rolls-Royce shares for now.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

christopherruane has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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