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Defence contracts could make the Rolls-Royce share price explode! Is it a buy?

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Despite some excellent fundamentals, the Rolls-Royce (LSE: RR) share price has lost a lot of value over the past five years. But with the announcement of a new US$2.6 billion contract with the U.S Air Force, I think we are on track to see a return to those highs and possibly push past them.

After debuting in 1987 as part of a wave of privatisation, Rolls-Royce’s share price traded sideways until the end of 2010, when the company secured a £750 million pound deal to supply and service jet engines on behalf of China Eastern Airlines.

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Since then, Rolls-Royce shares have been in a steady decline, losing nearly 75% of their value between 2018 and 2020. This can appear very scary to many new investors, but I think that this dip actually presents an excellent opportunity to get in while the company is undervalued.

Fundamentals

Price action isn’t everything when it comes to a share’s value. Rolls-Royce may have a few more outstanding shares than would be ideal (with a total number of 8.1 billion), but its price-to-earnings ratio is an astounding 3.62!

The company does also pay a dividend, but the value of that dividend moves up and down depending on how well the company is doing, which suggests good management that is focused on the long-term health of a company instead of the immediate wishes of shareholders.

The defence contracts

The contract making all the headlines today is the one Rolls-Royce has signed with the U.S.A.F to refit its fleet of B-52 bombers with new F130 engines. If all that is gibberish to you, all you need to know is that Rolls-Royce will be manufacturing these engines along with all of their spare parts from its factory in Indiana and is expected to be tasked with the maintenance of these planes all the way up until 2050.

On top of that, Rolls-Royce has also secured contracts to refit the U.K’s own aircraft carrier with a new engine and to design a propulsion system for the military jet developer AERALIS.

All of this makes me very confident that the Rolls-Royce share price is due for a return to its all-time high, with a real possibility of pushing past that number, and so I’m adding the shares to my watch list.

Problems ahead

With any investment, there are risks I must consider. There is a chance that Rolls-Royce may not be able to meet its contractual obligations or a change in the U.S administration may lead to an adjustment in priorities. However, I view this as unlikely since the recent AUKUS alliance shows a shifting of focus within the anglophone world, away from the Middle East and towards an ascendant China. We haven’t seen a Cold War type arms race since 1989 and many industries can expect to benefit from the U.S.’s desire to outmatch its rivals.

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James Reynolds 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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