Image source: Rolls-Royce plc
I love so much Rolls-Royce (LSE: RR) and previously owned shares. But while I would be happy to become a shareholder again if the right opportunity arises, I have no immediate plans. Instead, I’m waiting for a Rolls-Royce’s lowest price before buying – very low, in fact.
To begin with, I must admit that the last few years have not been short for blue-chip shareholders. FTSE 100 company.
In 2023, it was the best performer of any FTSE 100 share. Last year it came close to taking that title again (however AG failed).
In the last five years, the share has increased by 144%. In the past five years, however, it has not been swayed by the travel restrictions of the pandemic period and its impact on the demand for civil aviation.
Since October 2020, on the contrary, the price of Rolls-Royce shares has increased significantly 1,322%.
However, past performance is not necessarily an indicator of future expectations. This is where my concern about adding the share to my portfolio at the current price comes into play.
Strong fundamentals but a challenging business environment
Part of investors’ optimism about Rolls reflects the company’s strength.
It operates in a business environment that benefits from high barriers to entry: few firms have Rolls’ technological know-how.
Its large installed customer base is another business advantage. Buying an engine that may last for decades is only the beginning of the costs for an aircraft owner. It will also need to be serviced frequently and in most cases, owners choose to have the service done by the original engine company.
So far, so good. In addition, Rolls is benefiting from growing demand in the defense sector and could see growth in its energy business in the coming years.
But I see the biggest challenge in the civil aviation space and that is outside the control of the company.
Consider the reason for that 2020 slide in share price – and others before it, such as following the terrorist attacks in the US in 2001. Demand for civil aviation can go into overdrive for reasons beyond the control of the airline, let alone the engine manufacturer.
Why I don’t like the price
So while in principle I would be happy to buy Rolls-Royce shares again, I want to buy at a price that gives me a margin of safety that I feel is large enough to reflect that risk of a sudden drop in demand for civil aviation.
After increasing in recent years, Rolls-Royce’s current price-to-earnings ratio of 21 doesn’t give me what I think is a large enough margin of safety for comfort.
The price could go even higher from here, I think, especially if management delivers on its targets for cheaper financial performance.
If not, however, the share could crash – and I fear that could happen if demand for civil aviation faces another major external shock.
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