The name Rolls-Royce (LSE: RR) is familiar to air passengers around the world thanks to the aeronautical engineer’s well-respected name. But one thing that has not been taking off lately is the price of Rolls-Royce shares.
Over the past year, they have tumbled by 30%. They now trade for pennies. So, ought I to buy them for my portfolio hoping that in years to come, their value may rise to pounds not pence?
Business turbulence
The pandemic and associated travel restrictions hurt the air travel industry badly. While obvious losers included airlines like easyJet and British Airways parent IAG, the past several years have also been very challenging for engine makers such as Rolls-Royce.
It makes money by selling engines to aircraft leasing companies and airlines, many of which are now managing their costs closely. That means that some of them are less likely to order new engines than they were a few years ago. The engineer also makes money by servicing its installed base. That consists of thousands of engines. Servicing them is an important source of revenues and profits that can last decades after the initial engine sale.
A sharp fall in revenues meant that Rolls-Royce fell to a loss in the pandemic and diluted existing shareholders heavily to boost its liquidity. I see a risk that could happen again in future if demand for passenger air travel faces another sudden and sustained drop.
Future prospects
But the past is one thing. What about the future?
I think Rolls-Royce shares could benefit from growing demand for civil aviation. In many markets that has recovered to or surpassed pre-pandemic levels, although it may remain subdued in at least some markets for the short-term future. Increases in fuel prices could also hurt demand, which is a risk for servicing revenues at the firm.
I see opportunities for sustained growth in Rolls-Royce’s defence business, as many European nations have plans to increase their military spending.
It said last month that it expects civil aerospace engine flying hours to reach their pre-pandemic levels again only in 2024 — but it does expect them to get there. It also expects modest revenue growth in its defence division this year.
I think the long-term prospects are promising. But there are risks. As a multinational company reporting in sterling, I also see a risk to the firm’s financial performance due to the weak pound.
Why I own Rolls-Royce shares
I am a believer in long-term investing and from this perspective, I see a lot to like about Rolls-Royce.
It has seen demand recovering. Only a few companies have the knowledge and expertise necessary to make and service large aircraft engines, which gives the company and its rivals pricing power. That could be good for future profitability.
I think the current price of Rolls-Royce shares in pennies does not reflect the firm’s strength. If it can consistently return to profitability in coming years, I think the shares could trade in pounds again. But I am happy to hold my shares and even if the price does not get there soon, I have no plan to sell.
