Sometimes investing can feel a bit like a game of musical chairs – especially when the music stops. In recent years, FTSE 100 aeronautical engineer Rolls-Royce has been a star performer in the London market. Rolls-Royce shares have had an incredible run, going up 1,004% over the past five years.
But the past few weeks have seen the music stop. The share price has tumbled 18% in a matter of weeks. With the common definition of a crash being a fall of 20% or more in a short period of time, Rolls looks very close to that.
What is going on – and could this give me a buying opportunity to add this brilliant performer of recent years to my portfolio?
Civil aviation demand’s suddenly looking shakier
A key risk that’s put me off buying Rolls-Royce shares in recent years is the risk that an unexpected event outside its control could suddenly hurt demand in civil aviation.
That would be bad news for Rolls, as it has a large business not only selling but also servicing engines for airlines. As was demonstrated during the pandemic, when airlines fly their planes for fewer hours, the need for servicing becomes more infrequent. That’s a risk for both revenue and profits at Rolls.
Has such an event now happened? It is too early to say what the impact of the war in the Middle East will be on civil aviation over coming months.
But high jet fuel costs, reduced passenger confidence in some regions and weakening discretionary spending power in many economies feels like a risky combination.
We are already seeing some airlines start to cut flights from their schedules – and there could be more of that still to come.
Rolls-Royce isn’t a one-trick pony
Still, does that justify an 18% fall in Rolls-Royce shares? After all, the company hasn’t yet issued any public statement changing its full-year outlook on the back of the Middle Eastern conflict. It may never do so.
Meanwhile, the firm has a defence division that’s set to continue benefiting from heightened demand due to ongoing conflicts in both Ukraine and the Middle East, making some nations keen to bolster their military capabilities.
While high jet fuel prices are bad for airlines, they could potentially be good for demand in Rolls’ other main division: power generation.
I’m doing nothing yet
Still, while Rolls has more than one string to its bow, civil aviation is its largest business unit.
As we saw during the pandemic, when Rolls-Royce was on its knees and its shares traded for pennies, weakness in civil aviation demand can be very bad news for the whole company’s performance.
Even after its recent fall, I think Rolls Royce’s share price – 39 times earnings – offers me far too little margin of safety for that risk. So for now at least, I’m in no mood to buy. Instead, I’ll wait to see how the business — and share price — perform in the coming months.
