Rolls-Royce (LSE:RR) shares are currently generating a lot of interest for private investors, myself included, primarily because they are now a penny stock and everyone likes a potential bargain, but also because a positive investment case can be made for the company. With the shares having crashed since the onset of the Covid-19 pandemic in 2020 to just 90p today, I am considering whether Rolls-Royce shares are a buy for my Stocks and Shares ISA, but there’s a lot to consider!
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It’s important to point out that although Rolls-Royce’s share price being below 100p technically qualifies it as a penny stock, historically the term “penny share” has been applied to market tiddlers, the smaller companies valued at under £100m that, for example, during the dotcom boom one could buy for 5p a share and sell a week later for 20p on a scrap of good news. But Rolls-Royce has a market capitalisation of £7.6bn, with over eight billion shares in issue. It’s no tiddler, it’s a monster, even at these low share price levels, and it’s highly unlikely to multiply in value in a hurry. So I am not excited by the somewhat speculative market chatter surrounding its penny share status.
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However, I do like its investment case, or story. The reason for Rolls-Royce’s share price fall is primarily because its business depends so much on aviation, and aviation came to a standstill during the pandemic. But the pent-up demand for air travel is immense. We’ve seen the recent queues of holidaymakers at airports, the supply chain issues for businesses caused by seaports not functioning efficiently, the emerging middle classes in India and China that have money to spend on seeing the world. Unfortunately, in addition to ongoing pandemic travel restrictions overseas, there is now the Russia/Ukraine war, a cost-of-living crisis and high oil prices to contend with, which is not conducive to Rolls Royce’s customers placing new orders for aircraft engines and lucrative service agreements.
So while I feel the story is good, it’s just not quite here yet. It’s mid-term. But the stock market looks ahead too, and Rolls’ share price stabilised a month ago at 78p and has risen approximately 15% since.
There are also more strings to the company’s bow in its Defence, Power Systems and New Markets divisions. Indeed, at the AGM last month, chairman Warren East said: “We are confident that we have positioned the business to achieve positive profit and cash this year, driven by the benefits of our cost reductions and increased engine flying hours in Civil Aerospace together with a strong performance in Defence and Power Systems”.
The Defence business is particularly lucrative, and the electric planes being developed by the New Markets division could be a future game changer.
The downsides are that there is no dividend, high debt (but this is expected to be reduced by £2bn with the sale of ITP Aero this Summer) and, unsurprisingly, low profits. The £7.6bn stock market valuation is not cheap by any means, considering these downsides.
A recovery in global aviation is key for Rolls-Royce and, despite some more turbulence, I think the company could do well in the next few years. I am considering buying shares for my Stocks and Shares ISA in anticipation of this.
