Rolls-Royce (LSE:RR.) has burst out of the blocks, its share price rising 5.5% on Wednesday (1 April). The reason? Hopes that the Iran War could end in the coming weeks.
The engineer’s outperforming the broader FTSE 100, which is up 1.9% in mid-week trading. It’s perhaps no surprise — Rolls-Royce could be one of the biggest beneficiaries of a ceasefire, along with the airlines it supplies.
The shares have fallen 11.8% in the month to date. Could they be about to take flight again following today’s news? Despite what I said above, I’m not so sure…
Good news?
We’ve been here before, right? I mean, markets have rallied on political soundbytes suggesting the conflict could be a short one. Then shortly afterwards hopes faded, causing share prices to backtrack again. It was just three weeks ago that President Trump said that the war was “very complete” only for it to escalate.
In fresh comments overnight, the commander-in-chief told the press that the US “will be leaving [Iran] very soon,” and that military involvement could end in “two or three weeks.”
It’s quite possible, of course. And especially considering the political implications of what’s proved an unpopular war in the US and globally. But with uncertainty over what President Trump’s military goals are, and with US troops still building up in the Middle East, could today’s market rally be premature?
What’s the danger for Rolls?
So let’s look at the implications of this for Rolls-Royce shares. One problem I have is that the engineer’s shares still look expensive on paper. At £11.91 each, it has a forward price-to-earnings (P/E) ratio of 30.3 times. It’s still more than double the 10-year average.
With a premium like that, I fear the company could again fall more sharply than the broader market if optimism over ending the Iran War fades. Rolls’ near-12% share price drop over the last month is far worse than the FTSE 100’s 4% decline, and reflects the vulnerability of expensive shares when investor sentiment worsens.
A prolonged conflict creates a number of problems for the engineer. Rising oil prices are impacting airline profitability, which later down the line might dampen demand for new planes and power units. Yesterday Korean Air said it was introducing emergency cost-cutting measures to deal with the crisis.
It’s also likely soaring energy costs will impact the firm by fuelling broader inflation, hitting consumer spending. The result? Fewer flights that reduce large engine flying hours, and therefore the income Rolls makes from servicing power units.
Bottom line
The thing is, it’s possible the Iran War’s already caused damage that’s not yet reflected in the share price. So even if the conflict ends soon, any signs of weakness in the firm’s upcoming trading releases could still cause its shares to slump.
On the other hand, revenues from defence customers could pick up as the geopolitical landscape unfortunately ruptures. And over the long term, the outlook for the civil aerospace sector remains robust. But right now, I think Rolls shares are far too risky for me.
