It’s a hugely volatile time for stock markets, and for Rolls-Royce (LSE: RR) shares as well. It’s the FTSE 100‘s star performer over the last five years but even it couldn’t withstand the recent correction. But does that give investors an opportunity to buy it at a more attractive price?
As the Stocks and Shares ISA deadline looms on 5 April, the aircraft engine maker will be hovering near the top of many Buy lists. Prospective investors will be dazzled by past performance, with the shares up a staggering 980% in five years.
They may also be spooked by the dizzying price-to-earnings (P/E) ratio of just over 40. That’s well above today’s FTSE 100 average of around 17.
However, the Rolls-Royce P/E touched 65 just a few weeks ago. So it’s cheaper. But is it a bargain?
FTSE 100 star turn
The Rolls-Royce share price is plunging for the same reason as almost every other UK stock. Investors are spooked by events in Iran.
Yet its shares have fallen faster than the index. As I write, the FTSE 100’s down 8.5% in a month. Rolls-Royce shares have fallen 14.5%. That will have reduced £10,000 to £8,550, a paper loss of £1,450. One reason for the drop may be the valuation, which may deter bargain seekers. Another is that it’s taken a direct hit from the conflict.
Rolls-Royce still generates more than half of its revenues from its wide-body, long-haul civil aircraft engines. The bulk comes from ‘aftermarket’ services, such as maintenance and repairs, which are based on miles flown. With Gulf airports closed, fewer passenger planes are flying.
If the Strait of Hormuz remains closed, we’re heading for oil shortages. That’ll drive up fuel costs, make flying more expensive, and hit passenger demand. Flight rationing could make things worse, if it happens. Not good for airlines, and not good for Rolls-Royce.
Yet it delivered good news on 16 March, when Atlas Air Worldwide ordered 40 of its Trent XWB-97 engines to power 20 Airbus A350F twin-engine freighter aircraft. That’s Rolls-Royce’s first A350F contract win in the Americas.
Diversified and growing
The engineering giant also has diversification beyond civil aviation. On Thursday (26 March) its Power Systems division announced one of its largest defence contract wins ever, supplying PowerPacks to the German Bundeswehr’s Puma infantry fighting vehicles. Deliveries start in 2028.
Its Defence division is also benefiting from rising tensions. It makes combat jet, helicopter and naval engines, and benefits from stable, multi-year government contracts. Provided Western governments are willing and able to spend the money.
Rolls has another big opportunity in small modular reactors, or mini-nukes. Again, that depends on government action. It’s a terrific company, but can investors justify paying that valuation today?
Rolls-Royce is a company transformed. CEO Tufan Erginbilgiç has set ambitious earnings and cash flow forecasts, and smashed them. The forward P/E is a little less daunting at 30.8. But given today’s uncertainties, I think it’s a bit too expensive to buy now. If that correction turns into a crash, I’ll consider topping up my stake. Right now, I can see better value shares on the FTSE 100 and will prioritise them instead.
