Whenever I have covered the Rolls-Royce (LSE: RR) share price over the past few months, I have always highlighted that it could take years for the company to recover to 2019 levels of activity and profitability. This is a projection based on analysis by aviation experts. Their projections suggest the global aviation industry will not recover until 2023 at the earliest.
As Rolls’ largest and most profitable division is its civil aviation business, the company’s fortunes are, to a certain extent, closely linked to those of the aviation industry. Unfortunately, even though analysts predict a recovery by 2023, it could be several more years before the industry is confident enough to start placing orders for significant aircraft deliveries. Until these orders are in the pipeline, Rolls-Royce may continue to suffer.
Still, as I have noted before, the group has other strings to its bow. Its defence division is a steady revenue generator. Meanwhile, the nuclear business could become a significant profit centre over the next decade.
Considering all of these factors, I have been wondering how much the Rolls-Royce share price could be worth in five years.
Of course, it is difficult to predict the outlook for any company accurately, especially in such an uncertain environment. Nevertheless, by using what we know so far, I think it could be possible to place a ballpark figure on what the corporation could be worth in the best-case scenario.
Rolls-Royce share price valuation
Due to the nature of the company’s business, valuing Rolls-Royce on profitability alone is quite challenging. The organisation has only earned a net profit in two of the last six years. However, between 2015 and 2019, the group reported positive free cash flow. So, that is the metric I will use to value the stock.
In 2018 and 2019, the company generated an average annual free cash flow from operations of £800m. This was worth roughly 14.1p per share per annum. Based on the stock’s past trading history, it seems as if the market was willing to pay around 20 times free cash flow per share before 2020.
Rolls’ management reckons the company can produce £750m of free cash flow in 2022, although some analysts have been questioning whether or not this is possible. A more realistic target might be 2023 or 2024, which would correspond with aviation experts’ projections for the sector’s recovery.
Assuming the firm hits this forecast, and after taking into account the new shares issued last year to reinforce its balance sheet, I think the company has the potential to generate 11p per share in free cash flow within the next five years. A multiple of 20 times this figure suggests a price target of 220p within the next five years.
These are just projections at this stage. Plenty could go wrong between now and 2024, which may force management to reconfigure cash flow projections. There is also no guarantee the aviation industry will ever recover to 2019 levels.
Still, I think these numbers provide an interesting guide on how much the stock could be worth. That is why I would be happy to look past the company’s short-term headwinds and buy a speculative position for my portfolio.
Rupert Hargreaves 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.