Fresh bouts of market volatility have battered Rolls-Royce’s Holdings (LSE: RR) share price in recent days. The engine builder slumped to its cheapest since November 2020 this week before bouncing off these lows.
The Rolls-Royce share price remains firmly stuck in penny stock territory at 88p. And on paper it seems to offer excellent value.
City analysts expect Rolls-Royce’s earnings to rise from 0.11p per share in 2021 to 3.1p this year. Consequently the business trades on a forward price-to-earnings growth (PEG) reading well, well below the bargain benchmark of one.
Why I’d buy Rolls-Royce shares
So is now the time for me to buy Rolls-Royce shares? Here are three reasons why the answer could be ‘yes’:
#1: The civil aerospace market continues to improve. Flying hours for Rolls-Royce’s engines have rebounded strongly as Covid-19 travel restrictions have ended. The business said today that “passenger demand is recovering on routes where travel restrictions have been lifted” like Europe and the Americas. As a consequence, flying hours for its engines rocketed 42% in the first half.
#2: Defence spending increases. Rolls-Royce is also a major hardware supplier to military customers. It is therefore well placed to exploit rising defence expenditure as the geopolitical landscape worsens. On Thursday, the business celebrated a “strong performance” in this business line between January and June as well as its “strong order backlog”.
#3: Nuclear operations suggest a bright future. The UK government has spoken encouragingly of the vital role nuclear power will play in the country’s green energy strategy. It’s one that Rolls-Royce will play a critical role in by building a series of small-scale reactors across the country. The business is accelerating hiring in its nuclear division too to make the most of this growth opportunity.
Why Rolls-Royce is highly risky
However, there are several reasons why I’m still reluctant to buy Rolls-Royce despite its cheap share price. These include:
#1: Fresh turbulence for civil aviation. The outlook for the airline industry has muddied considerably in 2022. Rising inflation threatens to derail travel-related spending among consumers and businesses. Airline profits are also in jeopardy from a period of prolonged high oil prices and other ballooning costs.
#2: Will engine orders dry up? A fresh downturn in the aviation industry could constrain the recent recovery in Rolls-Royce’s flying hours. It might also cause aircraft orders to dry up again or prompt more plane cancellations that could hammer Rolls-Royce’s share price. AirAsia X recently cancelled an order of 63 Rolls-Royce engine powered A330neo aircraft with Airbus.
#3: Debt remains eye-wateringly high. Net debt at Rolls-Royce has risen sharply since the start of the pandemic and hit an enormous £5.2bn at the end of December. This has the potential to hit earnings growth by limiting investment. It could also put the enginebuilder in huge peril again if, say, the Covid-19 resurgence in China becomes a global issue again.
The verdict
The Rolls-Royce share is cheap. But I think the FTSE 100 firm still exposes investors like me to too much risk. I’d rather buy other UK shares today.
