Rolls-Royce: soaring performance; undervalued shares?
Despite reaching four-year highs, Rolls-Royce shares may still be significantly undervalued. With impressive 2023 results and ambitious future targets, is this aerospace giant poised for takeoff?
Strong growth underpins share price rally
Rolls-Royce demonstrated impressive growth in 2023, with underlying operating profit surging 144% to £1.59 billion and free cash flow more than doubling to £1.85 billion. The return on capital also saw a significant improvement, more than doubling from 4.9% to 11.3%. This strong financial performance sets the stage for a compelling investment case.
Still cheap despite the surge?
Despite these impressive results, Rolls-Royce shares are currently trading at a remarkably low price-to-earnings (P/E) ratio of 15.7, significantly below the average of 27.7 among its peers in the aerospace and defence sector. This disparity suggests that the stock may be substantially undervalued compared to similar companies in the industry.
Potential for growth
Further supporting this view, a discounted cash flow analysis indicates that Rolls-Royce shares could be as much as 52% undervalued. With a current price of £4.55, this analysis suggests a fair value of around £9.48 per share. While market movements can be unpredictable, this substantial gap between the current price and estimated fair value highlights the potential bargain Rolls-Royce shares represent.
Future outlook
Looking ahead, Rolls-Royce's prospects appear promising. The company recently received investment grade ratings from major credit agencies Fitch, Standard & Poor's, and Moody's. This upgrade not only reflects confidence in the company's financial health but also provides Rolls-Royce with better access to capital for future growth.
Ambitious targets and potential risks
In response to these positive developments, Rolls-Royce has set ambitious performance targets for 2027. These include substantial increases in operating profit, operating margin, and return on capital, as well as significant growth in free cash flow. However, investors should be aware of potential risks, particularly the challenge of scaling manufacturing capabilities to match sales growth, as evidenced by recent delays in engine deliveries for the Airbus A330neo.
Rolls-Royce share price – technical analysis
The current Rolls-Royce share price chart is a textbook uptrend. The price has made steady higher highs since late 2022, and has barely undergone any correction – it mostly just consolidates sideways before the next leg higher.
The price has remained above the 50-day simple moving average (SMA), which itself remains above the 100- and 200-day moving averages.
The recent pullback has found support at the 50-day, and now seems set to test the June highs, and then on to 500p. A close above 485p would see it move above the December 2015 lows, and also move on to new post-Covid-19 pandemic highs.
Rolls-Royce daily chart
This information has been prepared by IG, a trading name of IG Markets Ltd and IG Markets South Africa Limited. In addition to the disclaimer below, the material on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer and quarterly summary.
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