Over the past 12 months, the Rolls-Royce (LSE: RR) share price has bounced back, rising a monstrous 225%. As a result, it has captured significant attention from retail investors, leading to the question. Will this upward trajectory persist? At 221p, I think there’s room for more growth.
Share price momentum
Rolls-Royce’s share price has been on a rollercoaster ride over the past few years. The Covid-19 pandemic and subsequent standstill of air travel took a huge toll on the company, given the bulk of its revenues are generated through servicing jet engines. This led to the stock falling to a low of just 38p in October 2020.
The next two years weren’t any more forgiving. The share price hovered around the 100p level for most of 2021 and 2022, plagued by more lockdowns and profit warnings.
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However, in 2023 the stock has seen a complete turnaround. The main reason for this is the continued pick-up in post-pandemic travel, which is now translating into hard cash for Rolls-Royce. With more planes in the sky, Rolls’ engine servicing arm has picked up significant momentum. In addition to this, new CEO Tufan Erginbilgic has implemented strict measures to mend the company’s balance sheet.
The results of this have already been seen in the most recent (H1 23) results. Underlying operating profit reached £673m and free cash flow reached £356m. This compares with £125m profit and a £68m cash outflow for the same period in 2022. Full-year guidance for both metrics has also been raised. If Rolls can deliver on this guidance, I expect investors to push the stock higher.
Valuation perspectives
Given its meteoric rise, the higher share price has implications for its valuation. The company now trades at a price-to-earnings (P/E) ratio of 12, a figure that almost aligns with the FTSE 100 average. This valuation view suggests that the market has started to factor in the positive developments in Rolls-Royce’s performance.
While the stock may no longer appear severely undervalued, it’s important to remember that valuations should be seen in the context of a company’s growth potential. With a price-to-earnings growth (PEG) ratio of 0.24, the stock still looks cheap to me. This metric takes the traditional P/E ratio and factors in earnings growth. As a rule of thumb, anything below one is considered undervalued.
Not out of the woods yet
Despite the positive momentum, Rolls-Royce carries a heavy debt burden on its balance sheet. It stands at approximately £2.8bn. Although the company has made significant progress in reducing this, I still see it as a risk in today’s volatile macro environment.
In the current environment of rising interest rates, this substantial debt load could become a cause for concern. High interest rates can lead to increased interest expenses, potentially impacting the company’s profitability and cash flow.
The bottom line
Rolls-Royce’s recent journey has been marked by significant share price gains, a valuation that’s now in line with the FTSE average, and positive growth results. While debt still plagues the company, I see more room for the stock to grow. Hence, if I had some spare cash I’d buy the stock today.
