The name Rolls-Royce (LSE: RR) evokes quality. Flying in a plane and seeing its iconic logo on the engine cowling, I feel reassured. So it is surprising that Rolls-Royce shares trade for just pennies.
I already own some. But, at their current price, should I buy more for my portfolio?
Good or bad business?
Just because a company trades for pennies does not mean it is unsuccessful. Lloyds Bank shares sell for less than a pound, but it made billions of pounds in profit last year.
However, Rolls-Royce shares used to be worth a lot more than now. They have lost over a fifth of their value in the past year alone. That comes on top of a period when the shares had already been falling steeply. The 2018 trading levels above £3 per share seem a distant memory now.
The reason is clear: aviation has had a very tough few years. Reduced passenger numbers led to less demand for servicing civil aircraft engines. Meanwhile, some cash-strapped airlines have been reluctant to commit to large orders for new aircraft, hurting engine sales.
Set against those negative factors, though, Rolls-Royce has seen sustained demand in its defence division. Civil aviation is now getting closer to pre-pandemic levels in many markets, which should be good for engine servicing contracts. On top of that, some airlines have taken advantage of the uncertain environment to place large orders for new planes at cheap prices. Those planes will all need engines!
Why I think Rolls-Royce shares look cheap
In the long term, I expect aviation demand to keep growing. There may be more bumps in the road ahead, but a growing global population will likely lead to more flights. Some passengers choose not to fly for environmental reasons, but engine makers like Rolls-Royce are working to develop new ways to power aircraft that do not rely on fossil fuels.
Rolls-Royce is in a good position to benefit from this. Its brand is highly respected in the aviation industry. The company has a large installed base, with over 15,400 engines in use across a range of civil aviation customers. Cost cuts in recent years have put the firm in a healthier position financially, which should help profitability.
After some massive losses, Rolls-Royce is again profitable and free cash flow positive. There are risks, though. Shareholders were heavily diluted in 2020 to boost liquidity. If revenues tumble again in future, I see the risk of further dilution.
The market capitalisation currently stands at around £7.4bn. I think that is good value for a company with the attractive economics and long-term potential of Rolls-Royce.
My next move
I think Rolls-Royce shares could continue to move around in the coming months amid market volatility. Aviation demand is recovering, but problems at some airports may lead to it falling again. Meanwhile, key markets in Asia continue to see less flights than before the pandemic.
But I believe the long-term outlook for the company is positive and not fully reflected in the current share price. As a Foolish investor focussed on holding a stock for years, I would consider adding more Rolls-Royce shares to my portfolio while they trade for pennies.
