3 reasons why Rolls-Royce’s share price could plummet

The Rolls-Royce share price continues to trade in penny stock territory as fears over the global economy rise. Here’s why I worry the business could remain under the cosh.

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Could the Rolls-Royce (LSE: RR) share price be the best value on the FTSE 100 today? On paper at least, the engineer looks like a bargain relative to its predicted earnings trajectory.

City analysts are expecting Rolls-Royce’s profits to rocket as the travel industry keeps recovering. Rises of 1,640% and 132% are forecast for 2022 and 2023 respectively, following last year’s return to profit.

This means Rolls-Royce’s share price commands a price-to-earnings growth (PEG) ratio of below 1 for the next couple of years.

3 dangers to Rolls-Royce’s share price

That said, there are significant threats to these growth projections for Rolls-Royce. Some of these could threaten the Footsie firm’s profits over the longer term too. These include:

#1: Falling travel spending

Spending on travel has remained robust despite the impact of rising inflation on consumer spending. Latest Barclaycard data in fact showed spending on international travel had its best month in April since before the pandemic.

I’m concerned however that discretionary spending on items like holidays could begin to flag as inflationary pressures worsen. The knock-on effect for Rolls-Royce is a hit to airline profits which could consequently damage the rebound in new plane orders.

#2: Airline staffing problems

Labour shortages among airports and airlines are also endangering the expected rebound at Rolls-Royce. TUI and easyJet have cancelled hundreds of flights in recent days in response to these shortages. And more could follow across the industry as supply chain problems and staffing crunches persist.

Staff levels could take months to return to normal levels following the mass dismissals made during Covid-19 lockdowns. This also threatens the level of recovery in engine flying hours — and therefore the level of servicing income — for Rolls-Royce.

#3: Rising fuel costs

Oil prices are surging again and could continue soaring as the war in Ukraine heightens supply worries. The pressure on airlines’ profits could have short-to-long-term implications for aerospace businesses like Rolls-Royce.

Brent values in fact just hit 11-week highs following the EU’s decision to ban Russian oil imports. Airlines will be under increasing pressure to pass high fuel costs onto passengers to protect earnings. But this is extra dangerous at a time when consumers are already feeling the pinch.

The verdict

All that said, there are reasons why Rolls-Royce could still prove to be a wise investment right now. Its huge investment in low-emissions plane engines and on building nuclear reactors could deliver exceptional returns as the fight against climate change intensifies.

Extensive restructuring following the pandemic will provide a significant boost to earnings. I also like the formidable barriers of entry Rolls-Royce enjoys which insulates the business from significant competitive pressures.

However, the risks of buying Rolls-Royce shares are still colossal. As well as the dangers outlined above, the business also nurses a colossal debt pile that could hit its growth plans. And, of course, any global resurgence in Covid-19 cases could prove disastrous once more for revenues.

All things considered I’d rather buy other shares today.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be considered so you should consider taking independent financial advice.

Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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