The Rolls-Royce Holdings (LSE: RR) share price has been falling in July. At the time of writing, the stock has dipped 15% over the last month, to just over 90p. I think this is an example of buy the rumour, sell the news.
Investors bought into the reopening trade last October, lifting the stock from 35p to 135p in two months. But Rolls’ shares have drifted lower this year as the difficult reality of reopening has become clear. I think this slump could be a buying opportunity.
On the verge of recovery
At times like these, I find it pays to ignore the noise and stay focused on what’s actually happening at a business. At Rolls-Royce, I see a company that’s now on the verge of a recovery. I reckon there are three areas to watch.
First, airlines are starting to fly their long-haul aircraft again. These planes are the main users of Rolls’ big jet engines. Second, the company is nearing the end of a restructuring programme that should deliver £1.3bn of annual cost savings.
Finally, a recent report on Bloomberg suggests the company has is getting close to a final fix for the problems with its Trent 1000 engine. This has been an expensive embarrassment for the company, with total costs expected to top £2bn.
Together, these factors are expected to support a return to profitability next year. Analysts are currently forecasting an annual profit of £363m in 2022, rising to £581m in 2023.
With the Rolls-Royce share price sitting close to 90p, that prices the stock on 20 times 2022 forecast earnings, falling to just 12 times earnings in 2023. That seems reasonable to me.
What about zero emissions?
Airlines and aircraft suppliers are coming under pressure to make big cuts to their carbon emissions. To help meet these goals quickly without drastic cuts to flying, Rolls-Royce is working on a plan to make its engines compatible with “100% sustainable” synthetic fuels.
The company says that by 2030 all new engines will be “compatible with net zero.” By 2023, some existing models of engine will also be compatible with synthetic fuels, allowing airlines to clean up their existing aircraft.
In my view, innovations like these should help Rolls-Royce protect its market share and drive new growth over the coming decades.
Rolls-Royce share price: a cheap buy?
Would I buy Rolls-Royce at current levels? I’ve avoided the stock for a long time but I’m starting to be interested.
However, there are still some risks which are making me hesitate. Rolls-Royce is emerging from the pandemic with a lot more debt than it had previously. I expect that repaying debt will limit the group’s ability to pay dividends for a few years.
Another concern is that the business may not make the right choices when targeting net zero. Developing new technology for future generations of aircraft could be costly. The company won’t necessarily get it right first time. These extra costs could eat into the company’s profits in future years.
On balance, I think Rolls-Royce shares look fairly priced at under 100p, but probably not cheap. At this stage, I might consider opening a small long-term position, but I wouldn’t bet the farm on this FTSE 100 stock.
