It’s been a promising few months for Rolls-Royce (LSE: RR) after a challenging period. While the company is not out of the woods yet, the improving Rolls-Royce share price reflects growing confidence among investors that the aerospace giant is moving in the right direction.
Here’s what I think could happen in the next few weeks.
Disposals boosting the Rolls-Royce share price
The main reason for the recent uptick in the Rolls-Royce share price is the news of the company’s latest planned disposal. That should help the company achieve its target in selling parts of its business.
Why is disposing of assets seen as a positive thing? In short, demand fell in its core civil aviation business last year. So the company needed to shore up its balance sheet and focus on key strategic areas. Selling certain parts of the company allows management to focus more on the key business areas. It also improves the balance sheet. But I’d be surprised to see any more disposal announcements in October.
Management capability indicators
Rolls-Royce has struggled over the past few years partly due to management missteps. The current management has set out a plan of how to return the business to solid performance. A target for disposals formed part of that. Delivering on that burnishes management credentials when it comes to its plan to fix the business overall.
The next key thing I will be looking for from management is delivering on the expectation of turning free cash flow positive in the current half-year period. If it is able to do that, it will help relieve one of the biggest concerns which has dogged the Rolls-Royce share price over the past 18 months: liquidity. So far, the company has repeatedly said it is on target to achieve this goal. As time passes with no contrary indication, investor expectations are now set.
Upward potential for the Rolls-Royce share price
The market’s favourable reaction to the disposal news was stronger than I expected, as the disposal plan had been well signalled in advance. That suggests that investor sentiment may be turning more positive than it has been for a while. That could mean that any further good news in coming months also helps the Rolls-Royce share price.
Rather than assessing survival prospects, investors are now increasingly focussed on the future earnings potential of Rolls-Royce’s large businesses, such as civil aviation engine servicing and defence. With the company clearly in recovery mode, this could mean earnings expectations in coming years are upgraded. That could help boost the Rolls-Royce share price further. I’m not expecting news about that in October. But with positive momentum, even in the absence of specific news, I see further upside potential for the Rolls-Royce share price in October.
Why I’m on the sidelines
Despite my increasingly bullish stance on prospects for the Rolls-Royce share price, I am still not buying the company for my portfolio currently. Last year’s liquidity crunch saw a heavily dilutive rights issue. In this capital intensive business, I see that as a continued risk if there is another sharp downturn in demand.
I am optimistic the company will meet its target of free cash flow positivity in the current calendar half. But I’m waiting to see if that actually happens before considering my next move.
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Christopher Ruane 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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