Why Rolls-Royce shares could be a risky buy for me as inflation rises

The FTSE 250 index has been weak in January. But that is not true for every component of the index. This includes some of my own investments, like Cineworld, easyJet and National Express,all of which have made gains. I do not think this is a coincidence. They are all among the worst affected by the pandemic. And as Covid-19 wanes, their fortunes are rising. This is exactly the story I would expect to play out for Rolls-Royce (LSE: RR) shares too. In fact, this is already visible. The FTSE 100 stock has not performed too badly in the past month. 

From coronavirus to inflation risk

I think it is still risky though. The threat of coronavirus might just have been substituted for the risk from high inflation. Inflation reached alarming proportions in the UK last year, when it came in at 5%+ on a year-on-year basis for November 2021. It remained at these levels in the December reading as well, and is likely to stay pretty high through the year. Out-of-control inflation is not good for most stocks, but particularly not for stocks like Rolls-Royce.

Airfares could rise

The company’s biggest source of revenue is its civil aviation segment. It manufactures and services aero-engines for airlines. We know of course that the last couple of years have been exceptionally bad for travel, and air travel in particular. And it is unlikely that it will be back with a bang any time soon either, as travellers might still like to exercise caution. Now, they might also be deterred by potentially rising fares.

Rolls-Royce shares could be impacted

Crude oil prices have been on the rise, and some analysts predict that they could rise to $100 per barrel in 2022. Aviation fuel prices are closely linked, and could rise as well. It is quite likely that airlines are hedged by now, so they would not have to pay higher prices for fuel. But even then, prices could rise because of the rise in other cost categories. The one that I am looking out for is labour costs. In November in the UK, for instance, workers’ earnings fell in real terms as inflation rose faster. I think it is only a matter of time before wages start rising too. 

Positives for the FTSE 100 stock

These developments could keep the travel sector tepid for a while longer, in my view. And that includes Rolls-Royce. That said, I do expect improvements in the stock this year as well. Besides civil aviation, it also has other business lines like defence and power systems, which are pretty big in size too. And as of its latest results, which admittedly were released many months ago now, the defence segment was actually growing.

So, I think there is a possibility that the company could continue to strengthen even with the rising inflation risk. But as I have been saying for a long time, I am waiting and watching for now, seeing how things play out for it rather than buying Rolls-Royce shares outright.