Since hitting a post-Covid-crash high of 135p in December of last year, the Roll-Royce (LSE: RR) share price has been under pressure. The stock has fallen around 25% since it reached this level.
The sell-off accelerated last week, with the stock falling around 6%. Over the past 12 months as a whole, the Rolls-Royce share price has fallen 8%. It’s down 56% over the past five years.
However, I think the recent declines in the share price could be an opportunity for long-term investors.
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Overcoming challenges
I think the market has got it wrong here. Shares in the aerospace business have been falling in 2021, but the group’s outlook is only improving.
Compared to this time last year, Rolls’ outlook is entirely different. The company seems to have pulled through the worst of the crisis, the airline industry is back in the air, and the group has shored up its balance sheet.
Granted, the business still faces some severe headwinds. Its latest trading updated predicted a free cash outflow in the “region of £2bn in 2021.” That’s money flooding out of the business management will have to find from somewhere. The group highlighted its £9bn of liquidity in the same update, which should help it cover the cash outflow.
If there’s another more severe coronavirus wave, Rolls will face more losses. It’s unclear if the business could weather another two years of billions of pounds of cash losses.
Rolls-Royce share price opportunity
These are the main risks and challenges facing the Rolls-Royce share price. But the company’s long-term potential is encouraging. The corporation believes it can generate £750m of free cash flow by 2022. This projection is “based on 2021 widebody engine flying hours at around 55% of 2019 levels.” A positive free cash flow would put the business back on a sustainable footing and remove the need for further cash calls.
How likely is it Rolls will meet this target? I think there’s a 50/50 chance. On the one hand, the pandemic is still raging in Asia, and it seems unlikely this will change anytime soon. On the other, over in the US, the aviation business is booming. Some airlines are even hiring new pilots.
As such, it seems to me that the Rolls-Royce share price is a high-risk investment. Yes, the stock has potential, but many risks on the horizon could cause turbulence for the firm.
Nevertheless, it seems clear to me the stock isn’t reflecting the company’s improving fundamentals. As long as there’s no Covid resurgence and the aviation industry continues to recover, I think Rolls’ fundamentals will continue to improve.
Therefore, I’d buy the stock for my portfolio today as a recovery play. Although I’d keep the risks surrounding the Rolls-Royce share price in mind and re-evaluate my position if things change.
