The FTSE 100 has endured a tricky start to 2024 as hopes of scything interest rate cuts have receded. But the Rolls-Royce (LSE:RR.) share price has had no trouble maintaining altitude in start-of-year trading.
At 299.5p per share, the engineering giant is basically unchanged from New Year’s Eve. And despite its electric price rises of the past year — it was trading at 105.4p a year ago — the business still looks dirt cheap.
City analysts think earnings will soar 32% year on year in 2024. This leaves it trading on a price-to-earnings growth (PEG) ratio of 0.7. Any reading below 1 indicates that a share is undervalued.
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So should I load up on Rolls shares now?
Holding steady
Rolls-Royce supplies products and services across a wide range of sectors. But the health of the engineer is highly dependent upon a strong civil aerospace industry, as its emergency cash calls during the pandemic showed.
What is the state of the airline sector today? Largely speaking it looks in good shape, as a raft of trading updates have recently shown.
Delta Air Lines spooked the market at the top of the year by cutting its 2024 guidance. But since then a cluster of other major airlines including American Airlines and United Airlines have released guidance-beating results for last year and published sunny forecasts for the current year.
Defying gravity?
But can the aviation industry continue its strong recovery? Global interest rates are tipped to fall from this year in a move that would support consumer and business spending. However, reductions aren’t guaranteed as policymakers remain wary of a sudden inflationary spike.
Both the Federal Reserve and Bank of England kept benchmark rates locked this week, with the US central bank warning that it won’t cut rates until it has “greater confidence that inflation is moving sustainably toward 2%”.
With conflict in the Middle East affecting supply chains and boosting oil prices, the fight against inflation is far from won. And this casts a lasting cloud over the travel industry.
Higher energy prices would be especially bad for airlines by pushing up fuel costs. The subsequent impact on ticket prices could also damage passenger demand.
Debt worries
Rolls also has significant exposure to other sectors that are dependent on a strong global economy. And this worries me for a very big reason: debt.
A combination of rebounding revenues and heavy restructuring have helped the FTSE firm rapidly mend its balance sheet. But it still has significant amounts of debt to pay down (net debt was £2.8bn as of June). And a significant portion of this has to be repaid over the next couple of years.
The verdict
There’s no doubt that Rolls’ post-pandemic recovery has been incredibly impressive. Chief executive Tufan Erginbilgic’s self-improvement strategy has got off to a flyer. And this has helped improve the company’s prospects of reinstating the dividend, possibly as soon as this year.
But I fear that a bubble may have formed around the stock over the past 12-18 months. And it still faces significant risks that could blow its recovery off course.
On balance, I’m happy to avoid Rolls shares and search for other FTSE 100 stocks to buy.
