Rolls-Royce (LON: RR) stock price has drifted upwards in the past two months as investors re-adjust their expectations for the manufacturing giant. The stock ended the year at 93.2p, which was the highest point since July 22. It has risen by more than 43% from the lowest level in 2022.
Civil aviation demand
Rolls-Royce Holdings is an industrial giant that operates as an oligopoly in some industries. For example, the company competes with just General Electric and Pratt & Whitney in the wide-body industry. It has a 58% market share in the industry while the other two companies control the rest. Some of the aircraft that use its engines are Airbus A330neo and Airbus A350.
Rolls-Royce share price recovered recently after China started ending its Covid-zero strategy. This is a positive sign for the company since its civil aviation model uses the razor-to-razor model. In this, the firm makes tiny margins selling its engines but makes a sweet profit in long-term service contracts (LTSA).
In LTSAs, the company enters contracts with airlines and then charges them as power-by-the-hour (PBTH) contracts. It charges them engine flight hours (EFH). For example, if the company’s rate is $250 per EFH at an agreed price of $200 per EHG, then the firm makes $50,000 per month. Since the aircraft has 2 engines, this can run to $100k per plane.
Aircrafts are required to perform annual maintenance, which often happen after every 15k hours. In some instances, the engine can fly for much longer. The benefit of this model is that it lets Rolls-Royce have negative working capital since it is paid before delivering the service.
Analysts expect that the civil aviation industry will do well in 2023. Demand for wide-body travel is expected to remain high while flight tickets will ease slightly.
Rolls-Royce will also be supported by the stable defence and power industries. It has already won a few orders by the US Navy. Defence contracts are expected to rise as the economy recovers.
Risks and opportunities in 2023
The biggest opportunity for Rolls-Royce share price will be the continued recovery of global aviation. Analysts expect that more people will travel than they did in 2022 as flight cancellations and jet fuel prices ease.
Another big opportunity is its Ultrafan engine which will go to testing this year. Ultrafan will become the biggest aircraft engine ever developed and the most sustainable since it will run on Sustainable Aviation Fuel. It reduces carbon emissions by at least 80%.
Further, some analysts expect that the engine could help the recovery of A380 and Boeing 747 as wide-body aircraft rises. Still, it will take years for the engine to move into production.
Other opportunities for 2023 will be the falling cost of doing business and strong defence spending as global risks rise. The Russia-Ukraine war will continue while China and Taiwan concerns will remain. On the other hand, the top risks for the company are the weak US dollar and its lack of exposure in the narrow body engine.
Rolls-Royce share price forecast
Rolls-Royce stock chart by TradingView
The daily chart shows that the RR share price has been in a bullish trend in the past few days. It has moved below the 38.2% Fibonacci Retracement level. As I wrote in this article, the stock is about to form a golden cross pattern. It has also formed a small head and shoulders pattern.
Therefore, there is a likelihood that the stock will continue rising as buyers target the next key resistance point to watch being at 120p. A drop below the support at 80p will invalidate the bullish view.
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