The Rolls-Royce Holdings (LSE: RR) share price has fallen by 25% over the last year. The stock is still down by 50% from its pre-pandemic levels.
I’m not surprised the shares haven’t recovered fully. Rolls’ revenue fell by 37% last year and the group reported a £3.2bn loss. However, CEO Warren East has taken decisive action to raise cash and restructure the business. I expect these efforts to pay off, supporting a strong recovery over time.
Now that the future looks more secure, should I buy Rolls-Royce shares? I’ve been taking a fresh look.
What I learned from Rolls’ results
Rolls’ best-known business is its civil aerospace division, which makes and supports jet engines for airliners. With most airlines grounded for much of last year, flying hours were down by 57%. Revenue from this business fell by 37%, leading to a £2bn operating loss.
However, civil aerospace is only one part of this large business. I believe the other parts of the group could help support Rolls-Royce’s share price as the business recovers.
The biggest contributor to profits last year was Rolls’ defence division. This business generated an underlying operating profit of £448m in 2020, up by 8% from 2019. Defence activity hasn’t really suffered in the pandemic, providing great stability.
Another source of profits was the power systems operation. This makes engines for ships and other industrial markets. Power systems generated an underlying profit of £178m in 2020. Although this was 50% lower than in 2019, Rolls says demand is already recovering.
Finally, the ITP Aero business, which makes parts for jet engines, delivered a £68m profit. Rolls-Royce is actually trying to sell ITP Aero at the moment and says it’s in conversations with a number of buyers. I’d guess they’ll be reassured by the ongoing profitability of this business, which is supported by defence revenue as well as civil aviation.
Rolls-Royce share price: is it cheap?
Although Rolls’ stock is still trading 50% below pre-pandemic levels, I’m not sure how cheap it really is.
The reason for this is that the company issued 6.4bn new shares last year when it raised £2bn in a rights issue. This rescue fundraising increased Rolls’ total share count from 1.9bn to 8.3bn.
The number of shares issued by a company is important when calculating earnings per share. Even if the total profit is flat, earnings per share will fall if new shares are issued. This is known as dilution.
Rolls-Royce reported an underlying profit of £306m in 2019, giving underlying earnings of 15.9p per share. I estimate that earnings would fall to just 3.7p per share if the same profit was generated today.
At the time of writing, Rolls-Royce’s share price is 114p. This values the stock at 30 times 2019 earnings, after dilution. Broker forecasts for 2022 suggest that next year’s profits will be at a similar level to 2019. That means the stock is valued on 30 times forecast earnings, too.
For me, that isn’t cheap enough. Although I expect Rolls’ profits to rise above this level in the future, I don’t want to pay too much for future growth.
