I have covered Rolls-Royce (LSE: RR) multiple times over the past 18 months. I have watched the company struggle through the pandemic and rebuild itself as the world tries to move on from the crisis.
In the first few months of the crisis, Rolls focused on strengthening its balance sheet and cutting costs. Management’s fundamental aim was to reduce cash outflow and stabilise losses. The organisation achieved this in the first half of 2021.
However, despite management’s best efforts, the company’s aviation business has continued to struggle. And as I have noted in the past, until this division, which accounts for the majority of group revenues, returns to growth, the corporation’s outlook will remain uncertain.
It appears as if the industry is finally beginning to wake up after nearly two years in cold storage.
Industry recovery
According to the company’s 2020 annual report, revenues from its civil aerospace business accounted for 42% of group revenues last year.
This division constructs and sells aircraft engines to manufacturers. Rolls does not make a profit on each unit sold. Instead, it sells the units at cost and makes money on the subsequent service contract, which purchasers have to buy.
Aircraft engines require servicing after a set number of flying hours. As many planes have been grounded for the past 18 months, this has had a significant impact on the company’s top and bottom lines.
The good news is, travellers are now returning to the skies. To meet this growing demand, carriers are bringing aircraft back into service that were mothballed at the beginning of the pandemic.
At the same time, carriers are also placing orders for new aircraft. At the Dubai Airshow, held earlier this month, aircraft manufacturer Airbus received 408 orders for new planes. Peer Boeing received 101 orders.
Not all of the planes on order will have Rolls’ engines, but the fact that carriers are willing to buy new planes shows that the outlook for the industry is improving.
Rolls-Royce share price potential
As such, I am tentatively optimistic about the outlook for the business. It seems that after 18 months, the group has finally turned a corner. It now looks as if all systems are go for the recovery.
Of course, additional coronavirus restrictions could throw a spanner in the works. Rising labour and materials costs may also weigh heavily on the company if it cannot pass these charges on to customers. This would almost certainly have an impact on its growth potential over the next few years.
Despite these risks and challenges, I think the outlook for the Rolls-Royce share price has improved dramatically over the past couple of weeks alone.
As such, I would buy the stock for my portfolio today as a recovery play as the airline industry prepares for takeoff.
Rupert Hargreaves 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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