The name Rolls-Royce (LSE: RR) is undeniably iconic. The famous aircraft engine maker is responsible for keeping millions of people a year up in the air. But something else that has been up in the air in recent years is the Rolls-Royce share price.
Despite selling products for millions of pounds, the shares trade for pennies. I see this as a bargain and own some of the shares. But with the price stubbornly stuck in penny share territory – and 19% lower than a year ago – I have been wondering if there is something I am missing about the investment case that is scaring other investors away.
Future demand
Opinions vary about air travel demand in future as many people worry about its environmental impact. But I expect continued growth in coming decades. The global population continues to increase and air travel has become increasingly affordable.
But what may well change is how aircraft are powered. From hydrogen to biofuels, multiple proposed fuel sources for aircraft of the future are being researched by different companies. Rolls-Royce is actively engaged in this, from continuing to develop what it terms the “more efficient” UltraFan engine to testing sustainable aviation fuels. All of that adds costs, and some of the projects will end up going nowhere while others will take decades to reach fruition.
So while I feel confident that Rolls-Royce will be able to rise to the changing needs of the aviation market, the costs of doing so may weigh heavily on results for many years.
Orderbook worries
I think the Rolls-Royce share price could be suffering from less distant business challenges too.
The firm supplies engines for the Airbus A330neo plane. It emerged last month that airline AirAsiaX had reduced its order for the planes substantially. That is a sizeable blow for sales of the Trent 7000 engines Rolls-Royce would have supplied for the planes.
Rolls-Royce and financial turbulence
Another investor concern that has hurt the share price is how much the company suffered during the pandemic. Despite robust demand in its defence division, reduced civil aviation flying hours led the company to a large loss. To prop up its finances, it issued new shares, heavily diluting existing shareholders.
The company ended last year with £7.1bn in liquidity and positive free cash flow. But I do see a risk that if there is another sustained drop in civil aviation demand in future, Rolls-Royce could again see its finances under strain.
Why I’m bullish on the Rolls-Royce share price
I reckon those are quite some risks. However, I also think that they go with the territory of aero-engineering.
Rolls-Royce is in a capital intensive industry. Its end markets have a history of occasionally seeing significant, sudden drops in demand. Engines are costly and time-consuming to research.
The flipside of those risks is that they act as sizeable barriers to entry for the industry. So Rolls-Royce is one of only a few large engine aircraft makers and it has an excellent reputation. That gives it pricing power. Along with a large installed base and healthy order book, that should help the company grow profits in coming years.
I recognise the risks, but feel a Rolls-Royce share price in pennies offers good value for my portfolio.
