Is the Rolls-Royce (LSE: RR) share price a value trap? This is a question I have been thinking about a lot over the past year.
Before I begin, I should first try and define what a value trap is. In the simplest sense, a value trap is a stock that looks cheap but is cheap for a reason. This is generally because its ability to earn income has been permanently impaired.
A value trap
The classic example is the newspaper industry. In the late 1800s and early 1900s, the newspaper industry was booming. There was virtually no other way to get news at the time, and hundreds of papers across the country all competed for readers. However, over the next 100 years, the industry changed entirely as first radio, then television and the Internet replaced the daily and evening papers.
The newspaper industry today is only a fraction of its former self. As competition has grown, the industry’s ability to earn income has been permanently impaired. It is incredibly unlikely newspapers will ever be the primary source of news for the country ever again.
Is Rolls suffering the same fate? I do not think it is. For a start, it has a 30% market share in the engine market for wide-body civilian aircraft. This is unlikely to change any time soon as the technology is highly specialised and closely guarded.
The firm also has a robust nuclear energy and marine engineering business. Once again, both of these divisions benefit from the fact that the company only has a limited number of competitors globally.
Rolls-Royce share price outlook
While I do not believe that the company’s ability to earn income has been permanently impaired, I think it has been reduced. Over the past 12 months, Rolls has laid off thousands of staff. At the same time, airlines have put orders for new aircraft on ice. There is no telling when they will return to place new orders. Even if orders start to grow, with its slimmer workforce, it is not clear at this stage if Rolls will be able to meet the demand.
All of this makes it challenging for me to place a value on the Rolls-Royce share price. After recent job cuts, the company is smaller than it was at the beginning of the pandemic. That means it is likely to remain so as the sector recovers. That is not to say it will not return to growth in the long run. It might just take several years.
Considering all of the above, I do not think the Rolls-Royce share price is a value trap. However, I would not buy the stock today. I think it is just too hard to tell what the future holds for this business, which has struggled to survive the past 18 months.
