What I think is next for Rolls-Royce shares in 2021

2020 was a terrible year for Rolls-Royce (LSE:RR).  While management had previously expected RR to generate free cash flow (FCF) of at least £1bn, the pandemic changed everything. Due to the coronavirus, the number of flying hours in civil aviation dropped sharply. Management now expects negative FCF of £4.2bn for 2020. […]

2020 was a terrible year for Rolls-Royce (LSE:RR). 

While management had previously expected RR to generate free cash flow (FCF) of at least £1bn, the pandemic changed everything. Due to the coronavirus, the number of flying hours in civil aviation dropped sharply. Management now expects negative FCF of £4.2bn for 2020. Given the cash outflow, Rolls-Royce has had to issue more shares through a rights offering. The company also expects to end 2020 with net debt of between £1.5bn and £2bn when excluding lease liabilities. 

With that said, the future could be better than the past. 

While 2020 has been terrible, I nevertheless think 2021 will be better thanks to the development and rollout of vaccines. Pfizer’s vaccine has already been approved in both the US and UK and many other vaccine candidates look promising. 

With the arrival of a new year, here’s what I think is next for RR in 2021. 

Rolls-Royce shares: improving fundamentals

Although there is always the risk of new mutations for Covid-19, I think 2021 will be a ‘recovery’ year for Rolls-Royce. In particular I believe management will succeed in their effort in turning FCF positive sometime in the second half.

Due to the lean times, the company has cut costs a lot and analysts expect air travel in many developed areas to recover to a fair degree by the summer (if not early fall) given the vaccine roll out. 

Continue to try to strengthen balance sheet

Although Rolls-Royce expects to turn FCF positive sometime in the second half of 2021, I reckon management will continue to try to strengthen the balance sheet through asset sales. Indeed, management has said before that they intend to raise at least £2bn through asset sales, with ITP Aero being key among them. If management gets a higher than expected price for the asset sales, sentiment around the stock could benefit. 

I think management will also try to be conservative and not use any FCF to buy back stock or to pay a meaningful dividend this year too. 

Going green

While RR is planning to shrink in certain areas by selling assets, it is also trying to expand in other areas. 

Given that the market likes many green stocks right now, I believe management will continue trying to go more green. In terms of how I think they will try to do so, I don’t believe they will do big green M&A acquisitions in 2021 because Rolls-Royce still needs to improve its balance sheet. Instead, I think it will focus on trying to leverage existing R&D resources to try to create new or incremental green products, particularly in the company’s power systems division. 

From those efforts, I think Rolls-Royce has an opportunity to grow its sales long term. 

Given that I think the company’s fundamentals will recover over the next few years and I’m also optimistic over RR’s ability to develop new or incremental green products, I’d hold Rolls-Royce shares for the long term. 

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Jay Yao 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.

The post What I think is next for Rolls-Royce shares in 2021 appeared first on The Motley Fool UK.

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