The Rolls-Royce (LSE: RR) share price continues to sink as worries over runaway inflation intensify.
At just above 70.6p, the engineering company’s share price is within a whisker of sinking to its cheapest since November 2020. The Rolls-Royce’s share price is now 44% cheaper than it was at the start of the year.
My first instinct is to avoid the engineer and look for less-risky shares. But then its shares are dirt-cheap on paper and they could fly if market confidence suddenly improves.
Today the FTSE 100 firm trades on a forward price-to-earnings growth (PEG) ratio of 0.2. Any reading below 1 suggests that a stock is undervalued.
So should I buy Rolls-Royce shares for my portfolio? Or is this plummeting stock best avoided at all costs?
Recovery in danger?
The twin dangers of surging inflation and rising interest rates are weighing heavily on the share price right now. They threaten to crush consumer spending power and business expenditure on travel, thus putting the post-coronavirus airline recovery in jeopardy.
Comments from Gatwick Airport’s chief financial officer reveal the uncertain outlook for the travel industry. Jim Butler recently told the Financial Times that he was “cautious about what we might see in the winter or next year”.
He added that the cost-of-living crisis “could impact the overall propensity for travel”.
This spells trouble for Rolls-Royce as engine flying hours could descend again. Furthermore, a fresh weakening in airline profitability could also smack demand for new planes and consequently sales of the company’s hardware. This could have a significant impact on long-term earnings.
FX pressures
Rolls-Royce shares are also sinking due to worries over accelerating costs. The business was smacked hard by supply chains, inflationary pressures, and the fallout of the Ukrainian war between January and June. These caused it to swing to a £1.6bn loss in the first half.
The company has said that such issues “will persist into 2023”. As a potential investor I’m worried that they could be more severe and last longer than it expects.
Finally, I’m worried about how the sinking pound will impact Rolls-Royce’s bottom line. After all, the firm took a hit of £464m from adverse foreign exchange movements in the first half of 2022.
Sterling fell to record lows around $1.03 earlier this week. And chillingly, a fall below dollar (and euro) parity is looking increasingly likely too as traders flee UK assets.
The verdict
Look, I don’t believe that Rolls-Royce is a complete basket case.
It’s possible that the travel sector could remain more resilient than the picture I paint above. The business might also see sales of its engines to defence customers soar as arms expenditure picks up again. A focus on developing green technology like low-emissions engines and nuclear reactors is also a shrewd move as the fight against climate change intensifies.
But all things considered, I think the dangers of buying this FTSE 100 share far outweigh the potential benefits. And especially as Rolls-Royce has £5.1bn of net debt it still has to deal with. I’d rather buy lower-risk UK shares right now.
