Image source: Rolls-Royce plc
The share price chart of Rolls-Royce (LSE: RR) had, until lately, been a thing of beauty. Rolls-Royce share sold for pennies as recently as 2022 but this year hit a new all-time high north of £14.
Suddenly, though, things have changed – a lot. The Rolls-Royce share price has tumbled 15% in little more than a fortnight.
This month’s publication of strong annual results already seem a long time ago.
Still, as the shares tank, could this mean that one of the best-performing British blue chips in recent memory has again reached a level where I ought to consider adding to my portfolio?
Fingers in different pies
I do not think so and there is a good reason why.
Rolls operates in three key areas of business. Defence has seen demand increase in the past few years, following Russia’s invasion of Ukraine. The current war in the Middle East and increasingly unpredictable US military postures continues to push defence up the political agenda in many western states.
Rolls also has a power business. With oil prices surging, this too feels topical. I expect demand to stay robust for the foreseeable future.
It is the third of Rolls-Royce’s three business areas that I think explains why the share has been sliding: civil aviation.
Wars often see passenger demand tumbling. Higher oil prices are bad for airlines’ cost structures regardless of demand.
We are yet to see airlines become very vocal about this. But from closed airspace around some Middle Eastern countries to weakening consumer confidence more broadly, I believe civil aviation is going to suffer badly this year both in terms of passenger demand and costs.
When that happens, airlines tighten their belts. Aircraft engine servicing becomes less regular if planes log fewer flying hours, while preserving cash trumps splashing out on new fleets. That is bad news for engine makers.
The recovery in Rolls-Royce’s civil aviation business over the past few years has been a key driver to propel the shares upwards.
Now that that business faces multiple risks in the current economic and geopolitical climate, the same division could drag the share price further down.
This doesn’t look like a bargain to me
I have long been fearful that a sudden unforeseen event leading to a sharp downturn in civil aviation demand could be bad news for Rolls.
That may now be here and, worse, it could be exacerbated by soaring jet fuel prices.
Even after the recent fall in Rolls-Royce shares, they still look highly priced to me. Currently the price-to-earnings (P/E) ratio is 40. If earnings fall – a risk I see in the current environment for the reasons I outlined above – the prospective P/E ratio could be even higher.
Given the risks, I think the price may fall from here – perhaps a long way. I have no plans to buy any Rolls-Royce shares.
Fortunately, though, there are plenty of other shares in the current market that do still look like possible bargains to me.
