Why I think the Rolls-Royce share price could crush the FTSE 100 this year

Roland Head explains why he’d be a buyer of FTSE 100 (INDEXFTSE:UKX) engineer Rolls-Royce Holding plc (LON:RR).

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It’s been a good start to the year for Rolls-Royce Holding (LSE: RR) shareholders. Their stock has risen by 11% already this year, compared to just 2% for the FTSE 100.

Investors seem to be gaining confidence that chief executive Warren East can deliver on his turnaround plans. There’s certainly a lot at stake. If he’s successful, I believe Rolls shares could look cheap at current levels in a few years’ time.

On the other hand, with the stock trading on 32 times 2019 forecast earnings, if East is wrong, then the firm’s share price could feel the pull of gravity again.

The problem for investors is that the company’s profits are back-end loaded. When Rolls sells a new jet engine, it doesn’t really make any money. The profits for each engine come from after-sales maintenance and support contracts, which may stretch out for a decade, or more.

All of this is perfectly legitimate, but makes it harder for outsiders to gain an understanding of the firm’s profits.

A long-term buy?

Since taking over at Rolls, East has delivered clear and consistent guidance and has been quite open about the changes he’s made. He expects the group to generate free cash flow of £1bn by 2020 and is aiming for a figure of £1 per share in the “mid-term.”

To put this into context, free cash flow is expected to have been between £450m and £550m in 2018. Obviously, there’s still a long way to go, but if the firm can hit the chief exec’s targets, then the shares look a decent value to me at under £9.

With Asian growth expected to power the civil aviation market for some years to come, I think Rolls-Royce could be a profitable long-term buy.

An overlooked performer

For a £1bn company, AIM-listed James Halstead (LSE: JHD) isn’t very well known. That’s probably not a big concern for this family-run flooring business, which has a stable fan base of long-term shareholders.

However, if you like to invest in buy-and-hold stocks, you may be missing out by ignoring this firm. It’s been in business since 1915 and remains under family management, courtesy of chief executive Mark Halstead.

The company manufactures and sells flooring products in most major global markets. In an update today, management said that profit margins improved during the final six months of 2018. A record profit is expected for the half-year and the group’s net cash balance is also expected to rise.

Why I’d buy

Looking back through the firm’s accounts for the last few years, my sums show average dividend growth of 9% per year since 2013. During this period, the payout has generally been covered by free cash flow and by the group’s net cash.

The shares currently offer a dividend yield of 3.1%, which looks attractive to me, given the strong growth rate. Although the forecast P/E of 24 looks expensive, I could live with this, given the income that’s on offer and the firm’s stable long-term performance.

I see Halstead as a stock to start buying today, with a view to building a larger position during the next market crash or recession.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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