Aircraft engine maker Rolls-Royce (LSE:RR) is associated with high quality and prestige. But that may not be immediately obvious from looking at the Rolls-Royce share price, which is in pennies.
I think the shares may continue to trade below a pound for some time yet. Yet I would still consider buying them for my portfolio. Here, I explain why.
Business with a large moat
Billionaire investor Warren Buffett talks about the benefit to a business of having what he calls a moat. By that he means a competitive advantage that helps keep other companies at bay, like a moat around a castle.
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I reckon Rolls-Royce has such a moat. The development and capital expenditure costs required to bring an engine to market act as a high barrier to entry. On top of that, Rolls-Royce has a large installed base of engines, some of which will continue to need to be serviced for decades yet. As Rolls-Royce built them, it also benefits from the potential for long-term revenues by servicing the engines.
Aircraft are typically designed to work with specific engines. So for certain aircraft, Rolls-Royce has an in-built advantage when it comes to selling engines. If airlines opt for that plane, they will almost definitely buy Rolls-Royce engines for it. For example, the Airbus A350 uses the company’s Trent XWB engine.
Taken together, these factors all give the business a large moat, in my opinion.
Where next for the Rolls-Royce share price?
Not only does Rolls-Royce have an attractive business model, but its commercial performance has also been recovering after a rocky couple of years. It is profitable and generating positive free cash flow once more. The company is also benefitting from improving sentiment in the civil aviation market, which could translate to new engine orders.
Despite that, the Rolls-Royce share price has fallen 10% over the past year.
Clearly, some investors are concerned about the potential pace of recovery at Rolls-Royce. Airports are struggling to cope with the renewed demand in civil aviation, which could mean new engine orders take longer to materialise than hoped. There is also the risk that a worsening global economy could lead to less demand for flights, leading airlines to cut planned spending.
In the absence of blockbuster news like a massive new engine order, I think the Rolls-Royce share price could continue to drift. I do not see a specific driver for it to get above the one pound mark again in the short-term.
My move
However, my approach to owning shares is based on long-term investing. Aside from short-term price movements, I think Rolls-Royce has an attractive business model that could produce substantial profits over the coming decade.
I am not looking for an immediate return, so I see an opportunity for my portfolio while the Rolls-Royce share price is in pennies. I would be happy to buy and hold.
