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Will Rolls-Royce Holding plc’s shares ever breach £12?

Photo: David Monniaux. Cropped. Licence: https://creativecommons.org/licenses/by-sa/3.0/

Back in 2014, shares in engine maker Rolls-Royce (LSE: RR) were flying high at almost £12 a shot. Since then, they’ve dipped as low as 521p following a series of profit warnings and poor corporate governance. Will the company ever be able to recapture its former glory? Let’s take a look at the numbers from today’s full-year results. 

Historic loss

Today’s headline was the £4.64bn pre-tax loss made by the company following a huge writedown on financial hedges due to sterling’s recent weakness and case settlement costs (£671m) relating to corruption charges with UK, US and Brazilian authorities. Put simply, this is the biggest loss in the history of Rolls-Royce and one of the largest corporate losses ever reported to the market. Given this, it’s unsurprising that shares are down by over 5% already today.

Today’s awful figures also included a 2% reduction in underlying revenue at constant exchange rates following weakness in the company’s Marine division. But CEO Warren East — former head of software titan ARM Holdings — was keen to focus on the company’s transformation plan. In addition to reflecting that the firm had performed ahead of expectations over the last year as a whole, East commented that it made “good progress” on is cost-cutting and efficiency programmes, achieving over £60m incremental in-year savings in 2016. An additional £80m-£110m benefit is expected in the next financial year. Investors may also be comforted by East’s insistence on the need for “cultural and behavioural changes” to ensure that Rolls-Royce emerges as a “more trusted, resilient company” in the future.

Trading on 21 times forward earnings for the next financial year, shares in the £14bn cap FTSE 100 constituent still look very expensive, despite its fall from grace over the past few years. At just 1.76%, the forecast dividend yield is also nothing to shout about, even though comfortably covered by earnings. I have confidence that the shares should return to form (and perhaps even break new highs) once the many mistakes made by previous management have been rectified and the company has been able to introduce its long-awaited new Trent engines to the market. But I feel that there are far better opportunities in the market for those not already invested.

An alternative?

One such alternative might be industry peer, BAE Systems (LSE: BA). Over the last five years, shares in the £19bn defence, aerospace and security company have ascended over 90% to 612p. Performance over 2016 was particularly pleasing for shareholders as the company benefitted from the flight to relative safety following June’s shock referendum result. Given his pro-defence stance, BAE was also a beneficiary of Donald Trump’s election victory in November.

With earnings forecast to increase by 9% in the next financial year, BAE trades on 14 times earnings for 2017. This looks like a reasonable price to pay, even if the shares aren’t quite the bargain they were a few years ago. A forecast yield of 3.5% — while barely growing at all — is covered by earnings almost twice, suggesting that the bi-annual payout is safe for now. That said, those considering adding the company to their portfolio must be aware of the BAE’s substantial pension deficit. It will be interesting to see what progress it has made in addressing this issue when it next reports to the market on February 23.

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Paul Summers owns shares in Rolls-Royce. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.