The Rolls-Royce (LSE: RR) share price has jumped in the first few months of this year. Year-to-date, shares in the aerospace and engineering group have increased 12%. However, over the past 12 months, the stock is still off by 40%, despite its recent performance.
Nevertheless, the outlook for the group has dramatically improved over the past few months. As such, I’ve been reviewing the business recently to see if it could be worth adding to my portfolio as a way to play the UK economic recovery.
Rolls-Royce share price outlook
Today, the engineering group reported worse-than-expected losses for 2020. Rolls-Royce results showed an underlying pre-tax loss of £4bn for the year. Analysts were forecasting losses of £3.1bn.
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This loss included a £1.7bn underlying charge related to the unwinding of hedging contracts, which were designed to limit the group’s exposure to volatile exchange rates. Underlying revenues were £11.7bn, down from £15.4bn a year earlier.
Rolls-Royce’s primary business is the design and sale of engines for commercial aircraft. The company doesn’t make any money on the sale of each engine. Instead, it receives service payments over the life of the machine. These payments are generally based on the number of flying hours for each product.
This model can be lucrative. But with most of the global airline fleet grounded over the past 12 months, it’s become a thorn in the group’s side. Last year, flying hours were just 43% of 2019 levels.
Management is expecting this to change in 2021. According to the company’s latest update, flying hours could hit 55% of 2019 levels for the whole year. By 2022, flying hours will reach 80% of 2019 levels.
These figures suggest the company is in for a couple of years of uncertainty. However, they’re just projections at this stage. There’s no guarantee the market will recover as expected. A worse-than-expected performance could have a significant negative impact on the Rolls-Royce share price. That said, a better-than-projected performance could have a positive effect on the stock.
Risk and reward
After a year of restructuring, Rolls is now in a significantly better position financially to weather the storm. It has reinforced its balance sheet with £7.3bn of new equity and debt and launched a disposal programme to raise at least £2bn. A restructuring programme is also underway, which will ultimately see the company reduce the number of jobs across the business by 7,000.
Based on current projections, these actions should be enough to help the group pull through. But, like all other projections, there’s no guarantee it’ll be enough. If Rolls has to deal with another year like 2020 anytime soon, it’s highly likely the organisation will have to raise yet more money.
Still, management’s current forecasts show the business will turn cash-flow-positive in the second half of 2021. This should help stabilise the Rolls-Royce share price. Further, projections suggest the company has the potential to generate at least £750m in cash as early as 2022.
Based on these forecasts, I’d buy the stock for my portfolio today. But this isn’t a risk-free investment. And Rolls’ recovery isn’t a certainty. The global economic recovery will dictate the group’s performance over the next few years. If that falters, and the company’s outlook dims, the Rolls-Royce share price could go into reverse.
