airplane engine

Rolls-Royce (LSE:RR) shares have been under pressure for much the first half of 2021. However, a strong bounce from levels sub 100p in late summer allows the stock to make year-to-date highs at 150p in the autumn. With one eye already on next year, here’s why we think Rolls-Royce shares could reach 200p (levels not seen since before the pandemic).

Ongoing ties with key stakeholders

News came through last month about the new entity setup for the small modular reactor (SMR) business. This is a new area being funded by the UK government along with a partnership with BNF Resources and Exelon Generation. Rolls Royce SMR will be primarily focused on developing ways to deliver net zero power as part of the ongoing push for green energy in the UK and around the world.

It’s positive on several fronts. Firstly, Rolls-Royce will be a major shareholder in the new business. Although this is small right now, hundreds of millions is being poured into it, so it could really start to grow in 2022. Secondly, it reinforces ties with the UK Government. The grant is important here, but it also helps to keep Rolls-Royce in bed with regards to contracts around defense and aerospace. 

Transformation benefits continue

Another reason why the Rolls-Royce share price could do well next year is due to continued progress on the restructuring. Half-year results showed that the business was on track to achieve  greater than £1bn of savings in 2021. On top of this, part of the transformation is around slimming the business down.

Disposals are underway, with ITP Aero as one example that is being sold off to a private equity group. In total, targeted proceeds are expected to hit £2bn. 

If we continue to see a slimmer, more financially efficient business into 2022, it should bode well for the Rolls-Royce share price getting back to 200p. 

Watch out for travel restrictions

The key risk to our view remains the uncertainty around travel restrictions into next year due to omicron and other Covid-19 variants. Given the size of the commercial aviation unit, a lack of flying hours for major airlines that use Rolls-Royce engines would be a large negative. This was one of the main reasons for the underperformance in the share price during the stock market crash of 2020 and earlier this year relative to the FTSE 100 index.

The situation is very fluid, and is likely going to continue to be like this over the course of the winter. Yet the risk is high, and more so with a stock in this sector versus a defensive stock (e.g utilities, supermarkets) in the UK. This is definitely something for investors to think about before making a call on whether to buy shares right now.

Overall, we think that the potential rewards outweigh the risks, so are considering buying shares for our portfolio for the long-term potential upside.

AlphaPicks does not own shares in Rolls-Royce. To buy shares in these companies, register here with our preferred partner, EToro.

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