Image source: Rolls-Royce plc
Stock price chart Rolls-Royce (LSE: RR) until recently, it was a thing of beauty. Shares in Rolls-Royce traded for pennies as recently as 2022 but this year hit a record high north of £14..
However, suddenly, things have changed – a lot. Rolls-Royce’s share price has fallen by 15% in just over two weeks.
This month’s publication of the firm’s annual results is long overdue.
However, as a stock tank, could this mean that one of the best performing British blue chips in recent memory has once again reached the point where I should consider adding to my portfolio?
Fingers in different pies
I don’t think so and there is a good reason why.
Roll operates in three key business areas. Defense has seen an increase in demand in the past few years, following Russia’s invasion of Ukraine. The current war in the Middle East and the increasingly unpredictable US military posture continue to drive the political agenda in many western countries.
Rolls also has an energy business. As oil prices rise, this sounds like a topic as well. I expect demand to remain strong for the foreseeable future.
It’s the third of Rolls-Royce’s three business areas that I think explains why the share keeps shrinking: civil aviation.
Wars often see a drop in passenger demand. High oil prices are bad for airlines’ cost structures regardless of demand.
We are yet to see airlines talk more about this. But from the closed airspace around some countries in the Middle East to the general decline in consumer confidence, I believe that civil aviation will suffer badly this year both in terms of passenger demand and costs.
When that happens, airlines tighten their belts. Aircraft engine maintenance becomes less when aircraft get fewer flight hours, while saving the money trumpets from new aircraft. That’s bad news for engine manufacturers.
The recovery of Rolls-Royce’s public transport business over the past few years has been a key driver of the stock’s rise.
Now that the business is facing many risks in the current economic and political climate, a similar split could lower the share price.
This doesn’t look like a bargain to me
I’ve long feared that an unexpected unexpected event leading to a sharp drop in demand for civil aviation would be bad news for Rolls.
That possibility now exists and, worse, could be exacerbated by the increase in jet fuel prices.
Even after the recent fall in Rolls-Royce shares, they still look overvalued 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’ve outlined above – the potential P/E ratio could be even higher.
Given the risk, I think the price could go down from here – maybe a long way. I have no plans to buy Rolls-Royce shares.
Fortunately, however, there are plenty of other stocks in the current market that still look like potential deals to me.
