Just over eight years ago, in January 2014, the Rolls-Royce (LSE: RR) share price peaked at around £12.95. It’s been a long way down since then. Today, the shares trade at 83p, a fraction of their former glory.
I love buying top FTSE 100 companies at reduced prices and, at first glance, Rolls-Royce shares fit the bill. However, the point of buying bargain shares is to benefit when they recover. But what if they don’t?
Rolls-Royce shares have gone from bad to worse. Then even worse. The Covid pandemic was a real blow, as repeated lockdowns grounded flights all over the world. This was a disaster for the aircraft engine maker, which makes most of its money from long-term maintenance contracts, which are based on miles flown.
This FTSE 100 penny share remains grounded
Many investors saw their chance and piled in, and some made a quick profit, too. Rolls-Royce shares recovered on several occasions, but it didn’t last. In the last six months they have taxied along, threatening to take flight, but never doing so. Omicron didn’t help. This year the war in Ukraine has driven up the oil price and slowed the travel recovery.
Then in February, the engineering giant suffered another blow, when respected chief executive Warren East announced he would leave at the end of 2022. East spent eight years battling to turn this crate around after inheriting after a string of profit warnings. Investors already miss him.
Earnings have fallen from £16.59bn in 2019 to just £11,22bn last year. As a result, Rolls-Royce shares aren’t even a bargain, with a forward valuation of 41.6 times earnings. Operating margins are just 4.6%, and forecast to fall to 2%. There is no dividend. There wasn’t in 2020 or 2021 either.
Climate change is another threat, as politicians battle to cut carbon emissions. The Rolls-Royce ‘New Markets’ division focuses on electrical power for small aircraft. It’s hard to see the principle extended to long-haul jets. Making them more fuel efficient will cost money, and eat into profits.
I’d buy Rolls-Royce shares then sit tight
The argument in favour of buying Rolls-Royce shares is that these headwinds will turn into tailwinds once the world starts flying again. That day should soon be upon us, if it isn’t already. With the exception of China, Covid seems licked for now.
The cost of living crisis is squeezing budgets, but not everybody is down to their last penny. The better-off still have cash to spend. Civil aviation will be back, and Rolls-Royce shares should fly when that day comes. I don’t think it’s a surefire bet. Airlines will remain bruised by their recent harrowing experiences, and may be slower to invest in new engines.
In February, Rolls-Royce reported an operating profit of £513m, against a £1.97bn loss in 2020. Its pretax loss shrank to £294m from £2.8bn. It is pointing the right way but still has a long way to go. I’d buy Rolls-Royce shares today. Then I’d buckle up and brace myself for a bumpy ride.
