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New fears about a global banking crisis have sent stocks through the FTSE 100 plummeting again. engine builder rolls royce(LSE:RR.) share price has fallen another 3% in weekend trading. The last time it traded it was at 142.9 pence per share.
The blue chip is now down 11% from the 160p multi-year highs hit a fortnight ago. It now trades with a forward price-to-earnings (PEG) growth ratio of just 0.2.
Any reading below one indicates that a stock is undervalued. However, I for one do not plan to add this FTSE drop to my own stock portfolio. Here’s why I think investors should avoid Rolls-Royce shares.
Rebound
Revenue and profits have rebounded strongly after the end of the Covid-19 lockdowns. The company makes most of its profits from servicing civilian aircraft engines, demand for which has skyrocketed as people have taken to the air again.
The outlook here has improved since late 2022 after China also relaxed pandemic restrictions. In fact, emerging markets like this create incredible long-term profit opportunities for companies like Rolls-Royce.
The number of aircraft in operation will increase in the coming decades as the number of travelers from Asia, Africa and Latin America increases. Airbus predicts that world passenger traffic will grow at an average of 3.6% per year over the next 20 years.
As airlines build their fleets to accommodate this, Rolls could see engine orders and aftermarket revenue rise from current levels.
Turbulence
Despite this, however, I am not tempted to buy Rolls-Royce shares. My first concern is that its recent recovery in sales and earnings could come to a halt if the travel industry turns down again.
High inflation and central bank rate hikes pose a constant threat to the demand for tickets by tourists and business travelers. And if contagion in the banking sector spreads and the global economy tanks, travel activity could fall off a cliff.
Many cyclical stocks face near-term uncertainty in the current climate. But I’m especially worried about Rolls given the huge debts on his balance sheet. The costs of servicing its £3.3 billion of net debt are colossal. And you will have a hard time paying this off if the income suddenly dries up.
Analysts in JP Morgan recently called new CEO Tufan Erginbilgic’s plan to organically reduce balance sheet leverage a “risky strategy”. They commented that the plan leaves the company”highly vulnerable to any unexpected shock in the coming years”.
There are a number of factors at play that I think could cause such an impact to materialize.
An action I would avoid
I am also concerned that Rolls-Royce will not be able to effectively capitalize on the long-term growth of civil aviation.
It faces stiff competition from industry giants like GE Aviation and Pratt & Whitney to sell engines. These companies also pose a major threat to the FTSE firm’s planned return to the narrow-body aircraft market.
As I say, Rolls-Royce’s share price looks low on paper. But overall, I think there are more attractive UK value stocks to buy at the moment.
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