Is Now a Good Time to Buy Rolls-Royce Shares?
It’s possible that the FTSE 100 company is just pausing for breath before another charge higher. The cheapness of its stock (at least on paper) could certainly attract fresh interest from value investors before too long.
At 154.6p per share, Rolls-Royce shares trade on a forward price-to-earnings growth (PEG) ratio of 0.2 times, which is below 1, indicating that the stock is undervalued.
The Rebound Continues!
The rebound in Rolls-Royce’s share price has been driven by the airline industry’s post-Covid recovery. The company’s Civil Aerospace division is its single-biggest unit by revenues, and organic sales here jumped 25% in 2022.
Aircraft servicing revenues leapt as large engine flying hours jumped 35% year on year. Flying hours were still only at 65% of pre-pandemic levels, but a raft of positive airline updates suggest that they will keep rising sharply.
News this week of “high levels of demand and strong bookings” at easyJet shows that industry momentum remains strong. The airline even hiked its full-year profits forecasts following recent tradingSponsored Product.
Investor confidence in Rolls is also rising thanks to the healthy conditions in the defence market. Military spending is picking up as worries in the West over Chinese and Russian foreign policy grow.
Fellow engineer Senior’s market update on Thursday provided a useful idea of where Rolls is today. The firm, which also supplies technology to airlines and armed forces, said that the “strong commercial aerospace” recovery keeps rolling on. Sales at constant currencies were up 16% in the first quarter.
Why I’m Avoiding Rolls Shares
Having said all that, I still have concerns about buying Rolls-Royce shares for my portfolio.
I expect sales to military customers to remain robust in the short-to-medium term. But I’m not convinced that revenues at its Civil Aerospace division will keep charging higher.
Big questions remain over how sustainable the rebound in travel demand really is. Speculation abounds that robust ‘revenge spending’ for plane tickets following the end of Covid-19 lockdowns could peter out suddenly. Persistently high inflation could worsen any slowdown as consumers scramble to save cash.
At the same time, Rolls’ profits are in danger as supply problems persist and cost inflation remains elevated. Senior said today that it remains “mindful of the ongoing supply chain pressures in aerospace.”
I’m also put off by Rolls’ high net debts of £3.3bn. The cost of servicing its borrowings is huge and looks set to grow further as interest rates continue to rise.
What’s more, these debts could significantly hamper the firm’s ability to fund its highly expensive development programmes. This in turn could affect its ability to win future business against competitors.
So for the time being, I’m happy to ignore Rolls-Royce’s cheap share price. I’d rather invest in other value stocksSponsored Product right now.
Is It Time to Invest in Rolls-Royce Shares?
Rolls-Royce is a company that has been in business for more than a century, and it’s known for producing some of the world’s most powerful engines for commercial and military aviation, as well as power turbines for the oil and gas industry. Its reputation is due to the fact that it has a long-standing history of delivering reliable engines, turbines, and power systems.
Rolls-Royce’s shares had a rough year in 2020 due to the Covid-19 pandemic. However, with the gradual reopening of economies and resumption of travel, the company is seeing a rebound in demand. As previously mentioned, the rebound has been driven by the airline industry’s post-Covid recovery. The company’s Civil Aerospace division is its single-biggest unit by revenues, accounting for nearly three-quarters of its overall sales. This division focuses on producing engines for passenger aircraft, and its sales rose by 25% in 2022.
One reason many investors are bullish on Rolls-Royce is the increasing demand for military aircraft in recent years due to geopolitical tensions between the US and China, and Russia. Military spending is on the rise again, which is good news for Rolls-Royce, as it is also a major supplier for armed forces.
Another reason to consider investing in Rolls-Royce stock is its price point. At the time of writing, the company’s shares trade at around 154.6p per share, which puts them at a forward PEG ratio of 0.2x. This is well below the average PEG ratio of UK companies, which currently stands at 1.3x. Therefore, based solely on its PEG ratio, Rolls-Royce’s stock is undervalued.
That said, there are a few factors that investors should consider before buying Rolls-Royce shares.
Firstly, there is concern about the sustainability of the rebound in the travel industry. While there has been a resurgence in demand for plane tickets, there is no guarantee that this trend will continue as the global economy continues to face uncertainties. This is especially true given concerns over persistently high inflation and supply chain snarls.
Furthermore, the company still operates with a considerable amount of debt. This leaves it exposed to rising interest rates, which could hamper the company’s ability to finance its operations or invest in R&D projects.
Lastly, there are concerns over how the company is managing its operational costs given the ongoing supply chain woes.
Final Thoughts
Rolls-Royce is a well-known engineering company with a long-standing history of delivering reliable engines, turbines, and power systems. Its undervalued stock and potential for growth make it attractive to investors. However, its financial and operational risks should also be taken into account. While there is no guarantee that the stock will continue to rise in the future, it does offer investors a stock with potential upside due to its exposure to the rebounding travel and military industries. Ultimately, it is up to individual investors to do their due diligence and decide if the stock is a good fit for their investment strategy.
