Bullish: James Reynolds
Rolls Royce (LSE: RR) has had some very bad years recently, but its outlook going forwards is promising: if the company’s management can navigate some difficult financial waters, then I believe its share price will recover.
The biggest positives for Rolls-Royce are the numerous defence contracts it has signed with the U.S government. These contracts are to refit the U.S air force with new engines for their bombers. Rolls-Royce engineers will also be contracted to repair and supply spare parts for these new engines.
This alone is enough to make me bullish. The U.S has a vested interest in remaining the world’s preeminent hyperpower and has always been willing to spend as much as it takes to achieve this goal. It is a well-known fact that the U.S spends more on defence than the next 10 nations combined: it wants the best for its military and will spare no expense.
The contract may only be for £2.6bn for now, but if Rolls Royce impresses the U.S military, then it can expect to profit for decades to come.
This is why, despite an admittedly poor debt to asset ratio, some analysts are predicting a 9% rise in revenue each year going forwards.
While this growth isn’t incredible by industry standards, it has been enough for Rolls-Royce to turn a profit once again this year.
I believe that Rolls-Royce is undervalued and I’ll be adding it to my portfolio.
James Reynolds does not hold any shares mentioned.
Bearish: Royston Wild
The Rolls-Royce share price has risen an impressive 80% or so over the past 12 months. It’s perhaps no surprise that the plane engine manufacturer has soared as travel restrictions have been steadily unwound. However, it’s my belief that Rolls-Royce shares could now be looking overly expensive.
At current prices around 135p, Rolls-Royce trades on a price-to-earnings (P/E) ratio of 25 times for 2022. It’s a hefty valuation in my opinion given that the FTSE 100 firm isn’t out of the woods just yet. A setback in its turnaround plan, and/or fresh trouble for the aviation industry, could send its share price plummeting from recent levels.
The biggest threat to Rolls-Royce remains the ongoing Covid-19 crisis. In the near term this threatens to hammer servicing revenues, and further out could it have a disastrous impact on demand for its engines. Rising infection rates in parts of the world mean that some countries are tightening travel rules again, causing fresh worries for the aviation sector.
The prospect of a long and lumpy road out of the pandemic is particularly worrying given the huge amount of debt Rolls-Royce is nursing. It had £4.9bn worth of net debt on its books as of June. Not only could have a significant impact on the engineer’s growth strategy, such as an increased focus on green technology. It could also compromise Rolls-Royce’s very survival.
Cost-cutting and asset sales at the firm have generally gone well to date. But that huge debt pile might spook investors if Rolls-Royce’s streamlining plan starts to run out of steam. All things considered, I believe the engineer remains far too risky.
Royston Wild has no position in any of the shares mentioned.