Betting on a remarkable turnaround

Industrial companies have started the year well despite the rising challenges in the industry, including tight labor conditions. The Vanguard Industrial ETF (VIS), has risen by ~5%, in line with the S&P 500 index. In the UK, the Rolls-Royce (LON: RR) share price has soared by 7.25% and by ~68% from its 2022 low. Other UK industrial companies like Melrose Industries and BAE Systems have also surged.

Betting on a turnaround

Rolls-Royce Holdings is a company that is betting on a turnaround as its top sectors flourish. The civil aviation industry is set to do well, as evidenced by the performance of companies like IAG, Delta, and EasyJet. 

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Similarly, the defense industry is facing elevated demand and tighter supply as global tensions rise. Further, energy is a major issue as countries seek to diversify their power sources. All these are positive catalysts for Rolls-Royce’s share price.

Rolls-Royce investors are now hoping for clearer skies with no turbulence after several years of underperformance. For example, the firm came close to collapsing during the pandemic as aircrafts idled. In the aftermath, the firm laid off thousands, sold assets, and raised cash to shore up its balance sheet. 

A few years before that, it was forced to spend billions of pounds to repair its Trent engines, which were having cracks. As a result, its business model was disrupted, since Rolls-Royce makes most of its money when aircracts are flying.

Now, with a new CEO at the helm, investors believe that the company’s turnaround is underway. Tufan Erginbilgic,  the new CEO will likely unveil his strategic outlook in the upcoming financial results in March. He has room to do more, including slashing costs and ensuring that it sells engines at a profit. In most periods, Rolls-Royce sells at a loss and then makes profits in long-term contracts.

Therefore, as I wrote in this article, Rolls-Royce seems like a good turnaround investment if business conditions remain supportive.

Rolls-Royce share price catalysts

There are other catalysts that could push the RR share price higher. First, the company is set to benefit from the China reopening. In a recent note, analysts at Barclays said:

“As China unlocks, there will be a significant snapback of air travel demand. For Rolls-Royce, China and proxy-China represented just over a quarter of total engine flight hours in 2019, pre-Covid. There is a 70 per cent correlation between engine flying hours and the company’s share price, so this unlock is significant.”

Second, Rolls-Royce could make a comeback in the high-selling narrow body business. With its track record, the company could easily build a new engine since existing companies like General Electric and Pratt & Whitney can’t handle the demand. 

Fortunately, Rolls-Royce is testing a new engine, known as the UltraFan, which it could scale down for this project. I believe that a re-entry in the space would lead to significant value for the company considering that many airlines are focusing on the hub and spoke model.

Third, Boeing and Airbus have a major production challenge, which has increased the number of backlogs. To some extent, this is a negative thing for Rolls-Royce. However, airlines are compensating this by moving their aircraft like A380 and A330. Such a move will benefit Rolls-Royce. 

Finally, analysts believe that the company’s turnaround could involve undoing some of Warren East costly ambitions. In the past few years, the company has invested heavily in nuclear reactors and other future energy products like hydrogen and electric aircraft. While these are good projects, it will take a long time before they become profitable. 

Rolls-Royce share price analysis

RR share price has formed a golden cross, which is a bullish sign. It has also rallied above the 50% Fibonacci Retracement level. Also, it recently moved above the ascending channel shown in blue. Oscillators have also made bullish momentum. Therefore, the outlook for the stock is bullish, with the key resistance point being at 140p.