Rolls-Royce shares are down 18% in a month and I’m finally going to buy them

Investors who bought Rolls-Royce shares have been repeatedly disappointed, but I’m willing to take a chance on them before they recover.

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Rolls-Royce (LSE: RR) shares just go from bad to worse. Yet this remains one of the UK’s most traded stocks as investors still believe there is a great opportunity here. So far, it’s been a losing bet, with the stock sliding 80% over the last five years.

Bargain hunters who bought 12 months ago have lost 53.97% of their money. Anyone who bought a month ago is down 17.89%.

The civil aerospace, power systems and defence engineer may have a Roll-Royce name, but the underlying business is anything but smooth. The pandemic was tough on its aerospace business, which generates most of its revenues from maintenance contracts attached to its engine sales. These are based on miles flown, a disaster as Covid grounded fleets.

The shares have been a losing bet

A company that posted almost £4bn of pre-tax profits in 2017 suffered a £294 million loss last year. This year, it anticipates low-to-mid-single digit underlying revenue growth, but I suppose that’s better than nothing. Last year’s underlying operating profit margin of 3.8% will be repeated this year, which suggests the turnaround will take time.

Departing chief executive Warren East was admired for his valiant but doomed battle to turn this crate around. New CEO Tufan Erginbilgic is picking up the mantle at a pivotal time for the £5.54bn FTSE 100 business.

Rolls-Royce recently reported a drop in first-half underlying operating profit from £307m to £125m. While dispiriting, this also reflected £371m in research and development costs designed to grow the business.

Its Power Systems division reported record order intake, while Civil Aerospace engine flying hours continue to recover and its Defence arm boasts a strong order book. So all is not lost.

Yet we live in a world of worry, as supply chain problems persist, energy prices soar and inflation rockets, pushing up the costs of key raw materials like titanium. This will all weigh on any Rolls-Royce recovery.

The FTSE 100 is packed with stocks trading at price/earnings ratios of less than 10 while offering dividend yields of 5% and, in some cases, a lot more. Rolls-Royce trades at a whopping 185.5 times forecast earnings and doesn’t pay any dividends. It may restore shareholder payouts next year, with free cash flow now “modestly” positive, but I’m not holding my breath.

I’m taking a small punt on this stock

It still has debt of more than £5bn, although it also has access to £7.1bn of liquidity, including £2.6bn in cash holdings.

Rolls-Royce does have an exciting opportunity in building small modular nuclear reactors that can power a million homes for around £2bn a pop. However, this is a 25-year programme that demands upfront capital investment, so the payback time will be slow.

The same could be said of Rolls-Royce shares. I think they have an opportunity to snap back when sentiment improves. Since that is impossible to time, I’m going to take a small position in the next few days. I just hope I don’t end up joining a long line of unlucky gamblers.

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 assessed. Consider taking independent financial advice.

Harvey Jones doesn't hold any of the shares mentioned in this article. 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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