Fresh fears over a global banking crisis have sent shares across the FTSE 100 plummeting again. Engine builder Rolls-Royce’s (LSE:RR.) share price has dropped another 3% in end-of-week trading. It was last dealing at 142.9p per share.
The blue chip has now fallen 11% from the multi-year highs of 160p struck a fortnight ago. It now trades on a forward price-to-earnings growth (PEG) ratio of just 0.2.
Any reading below one indicates that a stock is undervalued. Yet I for one won’t be planning to add this FTSE faller to my own shares portfolio. Here’s why I think investors should avoid Rolls-Royce shares.
Rebound
Revenues and profits have rebounded robustly following the end of Covid-19 lockdowns. The business makes most of its profits from the servicing of civil aeroplane engines, demand for which has soared as people have taken to the skies again.
The outlook here has improved since late 2022 following the loosening of pandemic restrictions in China, too. In fact emerging markets like this create incredible long-term profits opportunities for companies like Rolls-Royce.
The number of jets in operation is tipped to balloon in the coming decades as traveller numbers from Asia, Africa, and Latin America balloon. Airbus predicts that global passenger traffic will grow at an average of 3.6% a year during the next 20 years.
As airlines build their fleets to accommodate this, Rolls could see engine orders and aftermarket revenues leap from current levels.
Turbulence
Yet despite this I’m not tempted to buy Rolls-Royce shares. My first concern is that its recent sales and earnings recovery could grind to a halt if the travel industry turns lower again.
High inflation and central bank rate hikes pose an ongoing threat to ticket demand from holidaymakers and business travellers. And if contagion across the banking sector spreads and the global economy sinks, travel activity could fall off a cliff.
Many cyclical shares face near-term uncertainty in the current climate. But I’m especially worried for Rolls given the huge debts on its balance sheet. The costs of servicing its £3.3bn worth of net debt is colossal. And it will struggle to get this paid down if revenues suddenly dry up.
Analysts at JP Morgan recently branded new chief executive Tufan Erginbilgic’s plan to organically de-leverage the balance sheet as a “risky strategy”. They commented that the plan leaves the company “highly vulnerable to any unexpected shocks in the next few years”.
There are a number of factors in play I believe could see such a shock materialising.
A share I’d avoid
I’m also concerned that Rolls-Royce may fail to effectively capitalise on long-term growth in civil aviation.
It faces severe competition from industry giants like GE Aviation and Pratt & Whitney to sell engines. These companies also represent a huge threat to the FTSE firm’s planned return to the narrowbody aircraft market.
As I say, Rolls-Royce’s share price looks cheap on paper. But on balance I think there are more attractive UK value stocks to buy right now.
