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Yesterday (21 April), the Rolls-Royce (LSE: RR.) share price tanked. While the FTSE 100 index lost 1%, shares in the aircraft engine powerhouse fell 6.5%.
Personally, I wasn’t so surprised by this outsized drop as it was related to a risk Iâve been warning investors about recently. This risk is the main reason Iâm not buying Rolls-Royce shares for my portfolio⦠yet.
Why did the share price plummet?
The 6.5% fall yesterday wasnât due to any news from the company. Instead, it was related to Q1 earnings from rival GE Aerospace.
GEâs earnings were actually quite strong. Revenue was up 29% on an adjusted basis while adjusted earnings per share was up 25%.
However, on the earnings call, management lowered its 2026 global flight forecast from mid-single-digit growth to flat or low-single-digit growth, with the Middle East expected to see a low-double-digit decline for the full year. In other words, the company is now expecting fewer flights globally this year than previously anticipated.
This could be an issue for Rolls-Royce because the bulk of its revenues comes from the servicing of aircraft engines, which is tied to âflying hoursâ. So, there may be fewer revenue opportunities this year.
Whatâs going on in the airline industry?
Why does GE now expect fewer flights this year? Because a lot of airlines are pulling back on or cancelling routes that arenât profitable due to the surge in oil prices.
Lufthansa, for example, has just announced that it will be cutting 20,000 flights amid soaring jet fuel costs. United Airlines also just announced it will be trimming some routes to reduce costs.
Iâll point out that I warned about this issue recently. Earlier this month, I wrote: âAlready, weâve seen some airlines reduce the frequency of flights to conserve fuel. If this trend continues, itâs likely to negatively impact Rolls-Royce.â
Whatâs next for Rolls-Royce shares?
So, where do the shares go from here now that the backdrop is changing? Well personally, I think they could potentially fall to around 1,010p in the near term.
One reason Iâm focusing on that price is that large numbers like 1,000p tend to act as a level of support. So, Iâd expect a lot of buyers to come in near that level.
Another reason Iâm focusing on that price is that last July, the stock jumped up from that level, creating whatâs known as a âgapâ in the share price chart (a price range at which the stock never traded). And more often than not, gaps tend to get filled at some point (donât ask me why).
1,010p would also bring the valuation down to a more reasonable level. At the current share price, the companyâs price-to-earnings (P/E) ratio is still in the 30s.
That seems a little high to me. A mid-20s ratio would be more appropriate, I feel.
When Iâll buy
Of course, the shares may not fall to 1,010p. My analysis could turn out to be totally wrong.
But if they do fall to that level, Iâll most likely be a buyer. Because I do continue to like the long-term story here, which is all about the defence and nuclear markets.
In the long run, I think the Rolls-Royce share price is going higher.
The post A new risk has emerged for Rolls-Royce and it could send the share price back to 1,010p appeared first on The Motley Fool UK.
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Edward Sheldon has no positions in any shares mentioned. The Motley Fool UK has recommended Rolls-Royce Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
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