Investors have been piling into Rolls-Royce Holdings (LSE: RR) in recent weeks. This was part of a wider return to risk on the FTSE 100, which saw travel, entertainment and mining stocks in demand as well.
That changed yesterday, when the Rolls-Royce share price crashed by 8%. It is down another 10% this morning. Some of you might see this as a buying opportunity. Personally, I wouldn’t.
The FTSE 100 aerospace and defence giant’s problems aren’t a flash in the pan. It has underperformed for years. While I am all for taking advantage of cheap FTSE 100 shares after they have been sold off, I think this is a risk too far.
I’d beware the Rolls-Royce share price
Thursday’s crash came after hedge fund manager AKO Capital dumped its entire 5.2% stake in the group. Today’s sell-off followed last night’s news that Standard & Poor’s Global Ratings has downgraded the group to junk status. After 20 years of investment grade status, Rolls-Royce’s long and short-term ratings have been cut to BB and B respectively. That hurts for such a prestigious brand.
I think this is a wake-up call for bargain hunters who were getting sucked into some of the riskier areas of the FTSE 100. Investors targeted travel stocks such as Carnival, IAG and easyJet as Germany and Spain eased travel restrictions. They were looking forward to a world where people would be happy to fly again.
We’re not there yet and even if we were, I felt they were making a big leap by extending that to the Rolls-Royce share price. Even if travel bookings do pick up, I think it will be some time before carriers will have the money and confidence to start making new plane orders.
A Rolls-Royce spokesperson insists the group is in a strong position, as “none of our borrowing facilities contain covenants or credit rating triggers that demand early repayment, nor do any of our contracts with airlines”.
There are better FTSE 100 bargains
That is good to hear, but I would still tread carefully. Chief executive Warren East already faced a major job turning around this sprawling FTSE 100 enterprise. The Rolls-Royce share price slump began long before Covid-19. Its stock now trades two thirds lower than five years ago.
The pandemic could be the opportunity he needs to give the engineering group a thorough overhaul. He has started, recently announcing at least 9,000 job losses as part of a plan to save more than £1.3bn a year.
It is going to take some time for the commercial aerospace market to recover, and it may never recapture its former size. Rolls-Royce was swift to cut its dividend in April. And despite its problems, it doesn’t look cheap by conventional metrics, trading at 20 times earnings.
I think there is a great case for buying cheap FTSE 100 stocks right now. The Rolls-Royce share price doesn’t tempt me.
Harvey Jones has no position in any of the shares mentioned. 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.