We examine whether Rolls-Royce stocks are undervalued in comparison to other stocks given that the present share price implies a market valuation of £12.6 billion.
Rolls-Royce stocks (LSE: RR) are now trading around the £1.50 level. They were 98p at the beginning of January.
Clearly, there has been a huge increase since the beginning of the year. But might the Rolls-Royce stocks still be a deal with a new CEO in place, determined to drive the company to new highs?
Rolls-Royce has been making progress in recent months towards overcoming a challenging time. Additionally, the stock has recently had a few tailwinds.
The resumption of air travel, especially long-haul flights, is the most important of these. This is significant since a significant portion of the business’s income derives from maintaining the aircraft engines it sells.
More usage calls for more frequent maintenance. And as a result, Rolls-Royce will generate more high-margin sales.
Another factor is that the business now has a new CEO. Tufan Erginbilgic has been open about his ambition to overhaul the business ever since he arrived.
The new CEO wants to increase profitability by increasing productivity. To survive the pandemic, Rolls-Royce had to lay off almost 20% of its workforce, but it appears that there may be further cuts in the future.
Due to all of this, the business’s next five years are probably going to be better than its previous five. Is the recovery already priced in, though, with the stock up 50% from the year’s beginning?
A $12.6 billion company?
Rolls-Royce currently has roughly 8.35 billion shares outstanding. Thus, a share price of £1.50 suggests that the corporation as a whole has a market valuation of about £12.6 billion.
Is that a lot? Depending on what else is available in the stock market, the stock may be undervalued if Rolls-Royce appears to be more likely than other companies to make money relative to its price.
There are some intriguing stocks for comparison within the FTSE 100. With its present share price, Rolls-Royce stocks is around the same size as Bunzl (£10.6 billion).
Bunzl is not in the middle of a turnaround like Rolls-Royce is. Although it may be more stable now that it has been developing slowly and gradually, there is less room for development.
Rolls-Royce anticipates an operational profit of roughly £800 million this year. Bunzl managed £757 million last year, and this year they anticipate managing more money.
However, Bunzl has a significantly stronger balance sheet than Rolls-Royce does. It may be argued that Bunzl is in a better position to turn its profits into free cash because it has less debt and less interest to pay.
Why the Rolls-Royce stocks remain at 150p
The share price of Rolls-Royce has been trading in a pretty narrow range around the 150p level for the previous three months. It has fallen below 145p and briefly risen to 155p, but it now appears to be stuck in the middle and unable to move significantly either higher or lower.
The reason why Rolls-Royce stocks are stagnant at about 150p and what can trigger a price change is explained below.
Investors floundering
The price of the shares has increased by 70% in the last year. That’s a significant change, especially when contrasted with the FTSE 100’s single-digit percentage rise during the same time span.
This sharp increase in price is partly responsible for its recent consolidation. People pause and consider where a stock will go when it makes such a significant move.
This change was motivated by Rolls-Royce’s strong full-year results, which were announced back in February. It performed better than 2021 results in almost every statistic. This enabled it to achieve a profit before tax of £206 million, up from £36 million the year before. With the new plan, the outlook for 2023 was likewise quite positive.
We believe that recent water treading is a result of investors waiting to see if this perspective will materialize or not. Were the results from the previous year a fleeting phenomenon? Only time will tell, and we may have to wait until August to see the results for the first half of the year.
Currently a reasonable price
The change in valuation is another factor contributing to the share price stagnation. The price-to-earnings ratio is a well-known measure of valuation. We are unable to use it though because of negative basic earnings per share from the previous year. However, we may use a projected P/E ratio of 30 to gain a sense of the situation right now based on the anticipated 5p earnings per share for 2023.
The P/E ratio has risen as a result of the growth in share price during the previous year. It was simpler to argue for buying Rolls-Royce stocks six months ago when the company was trading under 100p, on the grounds that it was undervalued.
However, today, we would contend that it is appropriately valued at 150p with a ratio of 30. For instance, two competitors in the same industry, Howmet Aerospace and MT Aero Engines, have P/E ratios of 29.6 and 25.2 respectively.
Any P/E ratio will be determined by the share price movement up until the earnings per share number changes. The stock may therefore find it difficult to move much because some investors believe it to be fairly valued.
Deciding what to do
Investors should still think about buying now for long-term prospective gains if they anticipate that the August results will be impressive. But we don’t believe it’s the greatest purchase right now for those who aren’t certain about it.
Should you buy Rolls-Royce stocks?
In conclusion, we believe that the current price of Rolls-Royce stocks is fair. They do, at least when compared to another FTSE 100 stock that is now trading at a similar price.
Right now, we can see a case for the stock in either direction. If the new CEO’s plans for increased efficiency are successful, earnings may increase and the stock may become undervalued.
Similarly, we believe there is a strong case to be made that the risks are too high right now. Instead, we would turn to Bunzl if we were looking to invest in shares of a company with a £12 billion price tag.
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