To say there’s been some turbulence with Rolls-Royce (LSE:RR) shares in recent times would be an understatement. Five years ago, the stock was trading above £3. Then, in 2020, Covid-19 grounded the global aviation industry and sent the shares crashing to 39p. The price then more than tripled to reach £1.44 just a year later. Today, shares sit around 79p!
While this volatility seems like a day trader’s dream, it does give me pause for thought as a long-term investor. Should I ignore the market’s uncertainty about Rolls-Royce and start to accumulate shares?
British industrial heavyweight
I’ve recently been looking to take advantage of the market downturn and add established, industry-leading companies to my portfolio. This led me to cast an eye over Rolls-Royce, which is both established and an industry leader.
The engine maker is synonymous with British industrial success. Founded in 1906 in Manchester by Charles Rolls and Henry Royce, the company today is a global leader in civil aerospace and defence. In fact, Rolls-Royce is the second largest provider of defence aero-engine products and services globally.
This is all well and good, but what about new opportunities? Where will the growth come from to power Rolls-Royce’s future profits and ultimately send shares higher?
Future opportunities
It seems likely that Russia’s invasion of Ukraine will prove a lucrative tailwind for Rolls-Royce’s Defence division, which sells military hardware globally. The company has already secured an order backlog of over £1bn for the first half of this year from customers planning to beef up their defence systems.
Also, new prime minister Liz Truss has pledged to increase the UK’s defence budget to 3% of gross domestic product (GDP) from 2%. This equates to an extra £27bn of spending. Deutsche Bank has said this ”could be a structural positive for UK defence stocks”, particularly industry giants like Rolls-Royce.
Another area of potential growth I find intriguing is in space exploration. Morgan Stanley estimates that the global space economy could be generating revenue of $1trn or more by 2040.
Rolls-Royce is developing a uniquely deployable nuclear Micro-Reactor for use in space. This would provide continuity of power for critical operations in the exploration of the solar system and beyond. This portable reactor is equally well suited to use on Earth, and could eventually be in high demand in a net-zero emissions economy.
Balance sheet risk
Unfortunately the company is still saddled with billions of pounds of debt after the aerospace industry was shut down during the pandemic. Management is selling off assets to help pay down this debt. I’d like to see progress here before I consider investing.
To help create generational wealth, a stock would have to perform well in my portfolio for many years or even decades. But Rolls-Royce shares have lost 75% of their value in five years. That’s hardly wealth-building performance!
Of course, this doesn’t mean the next five years will be as underwhelming. There are positive signs of future opportunities, particularly in its Defence division. But I still need more evidence that the company’s best days aren’t behind it before I buy shares. Rolls-Royce remains on my watchlist for now.
