The name Rolls-Royce (LSE: RR) evokes quality and sturdiness. But the same thing might not be said about Rolls-Royce shares, which have had a bumpy few years. They currently sell for pennies and have lost 30% of their value in the past year alone. They are worth barely a quarter of their price of five years ago.
Where did it all go wrong? And does the current price offer me a buying opportunity?
Good industry, bad time
While the company itself has made some strategic missteps, I think the main problem for Rolls-Royce has been unpredictable demand in civil aviation due to the pandemic. Coupled with that, many airlines have had to cut back on their fleet expansion plans and focus instead on survival.
That matters for Rolls-Royce as selling and servicing engines is core to its business.
Servicing is bigger business than many people may realise. In the first half, for example, the majority of Rolls-Royce’s revenues came from servicing engines not selling them. A slowdown in civil aviation demand meant that servicing revenues fell sharply in recent years. That has been a leading cause of the fall in the share price.
The airline industry seems to have a rough patch every now and then, affecting the fortunes of engine makers such as Rolls-Royce and rivals like GE and Pratt & Whitney parent Raytheon. I do not like that element of the business model. But I think there are other factors that can make aeronautical engineering an attractive business. Long-term demand is set to remain high. Customers are willing to pay large sums for quality engines.
The barriers to entry are high as designing, testing and building engines is a complex, costly process. This means that, in good times, Rolls-Royce should be able to make large profits. In the first half, for example, although it reported a loss, that was due to financing costs. Before taking them into account, it made a modest profit. I think the basic economics of the business remain attractive. That could form the basis of strong future financial performance.
Should I buy Rolls-Royce shares?
The key here, however, is that one needs to be willing to take a long-term view. As I am a believer in long-term investing, that suits me fine.
I do think the business could do very well again in future. If that happens, then today’s share price of around 80p will perhaps look cheap. That is why I have been buying Rolls-Royce shares for my portfolio.
But the good news may take years to arrive. There could also be bumps or more unexpected demand shocks to the industry along the way. The business expects engine flying hours to get back to where they were before the pandemic in 2024. But further travel slowdowns could hurt demand. For example, that could happen because in a worsening economy people have less money to spend on leisure and business travel.
Recognising the risks and focusing on the long term though, I continue to see value in Rolls-Royce shares at their current price. I would happily add more to my holdings.
