Back in 2019, Rolls-Royce (LON: RR.) shares were trading above 300p. Today, however, they are changing hands for just over 200p. So, why has the Rolls-Royce share price dropped? And what’s the outlook for the shares looking ahead?
The reason Rolls-Royce shares have fallen in recent years is quite simple, COVID.
Rolls-Royce generates the bulk of its revenues from the manufacturing and servicing of engines for the commercial aviation industry (much of its revenue is linked to flying hours).
Dduring the coronavirus pandemic, these revenues dried up due to the fact that so many planes were grounded as a result of country lockdowns.
This drop in revenue led to large losses. In 2020, for example, the Rolls Royce made a loss of £4 billion (versus a profit of £306 million in 2019).
It also led to a large decline in cash flow from operations (cash flow from operations came in at -£4.3 billion in 2020).
With its finances under pressure, Rolls-Royce was forced to raise capital, and in late 2020, it raised £2 billion via a rights issue in an effort to shore up its finances.
Ultimately, this combination of large losses, negative cash flow, and a capital raise (as well as general uncertainty in relation to when the pandemic would end) had a disastrous impact on the Rolls-Royce share price.
At one point, the Rolls Royce share price fell as low as 65p.
The good news for Rolls-Royce investors is that today, the shares are making a rapid recovery.
This year, Rolls-Royce’ share price has climbed back above 200p. At one stage, in September, it was above 230p.
This recovery is down to the rebound in the civil aviation market after Covid-19 as well as a transformation programme put in place by new CEO Tufan Erginbilgic.
As a result of improved market conditions and a focus on efficiency, the company’s profits have risen sharply.
For the first half of 2023, for example, Rolls-Royce reported an underlying operating profit of £673 million – more than five times the figure posted a year earlier.
Meanwhile, it raised its full-year 2023 profit forecast to £1.2 billion to £1.4 billion from previous guidance of £800 million to £1 billion.
Can Rolls-Royce shares continue to rise from here?
Potentially. If the company can continue to cut costs (it recently announced plans to cut 2,500 jobs) and increase its profits, there could be further share price upside in the near term.
However, it’s worth noting that Rolls Royce stock does have quite a high valuation after its recent gains.
Currently, Rolls-Royce trades at around 23 times this year’s forecast earnings. That’s well above the UK market average (approx. 13).
In light of this high valuation, and the fact that the Rolls Royce shares have risen more than 100% this year, it is probably sensible to approach the stock with caution right now.
After that kind of gain, there is always the chance of a significant pullback.