Just as the world begins to emerge from the darkest days of the pandemic, the Rolls-Royce (LSE: RR) share price plunges again. At prices near 89p, the stock is around 24% lower than its level in late February and roughly 21% lower than a year ago.
But in fairness, Rolls-Royce isn’t the only stock that’s fallen because of the recent escalation of troubles in Eastern Europe — there have been many. And value-seeking investors have been presented with several choices for potentially enduring stocks to hold for the long term.
But how about Rolls-Royce? Is it a viable candidate for my portfolio?
Turning itself around
The arrival of the pandemic and the grounding of most of the world’s aircraft hit the business hard. And for a while, it looked as if its very existence was under threat. Indeed, operations had been unprofitable leading up to the crisis. So the pandemic dealt the company a bitter blow when it was already struggling to get back on its feet.
But after some financial manoeuvres and re-financing, the company pulled through. And now, after making huge losses in 2020, the business has been scratching a small profit.
In fact, City analysts expect earnings to increase by almost 50% in 2023 to about 7p per share. But to put that in perspective, it’s around 15% of the level of earnings the business achieved in 2017.
Set against that expectation, the forward-looking price-to-earnings ratio is just over 13. And at first glance, that valuation seems fair. However, Rolls-Royce has a patchy multi-year record of earnings and it hasn’t paid a shareholder dividend for years.
On top of that, the firm’s debt load is big. And adjusting for that would add about two thirds again to the valuation multiple making the stock look less attractive.
A positive outlook
In February, the company delivered its full-year results report for 2021. And the headline said: “A better balanced and sustainable business”. There’s no doubt Rolls-Royce has been working hard to turn its business around.
Underlying profit came in at £414m in 2012, which is a vast improvement on the £513m loss made the year before. And the directors said free cash flow “substantially” improved “ahead of expectations”.
The company achieved restructuring “run-rate” savings of more than £1.3bn, which the directors said arrived a year ahead of expectations. And the company expects to gain around £2bn from disposals.
Chief executive Warren East said the Civil Aerospace division is positioned to benefit from increasing international travel. And the Defence division is seeing growth driven by “strong” demand. Meanwhile, the Power Systems division saw “record” order intake in the final quarter of the year.
Looking ahead, East said the company is making “disciplined” investments to develop new and existing technologies. And that will, he reckons, enable Rolls-Royce to benefit from “significant” commercial opportunities arising because of global energy transition.
I don’t believe Rolls-Royce is a bargain, despite its ongoing operational progress. However, it’s possible for the stock to make decent long-term progress for shareholders as the underlying turnaround continues. However, I’ve decided to watch events from the sidelines.
