Is the Rolls-Royce share price seriously undervalued?

The Rolls Royce share price has struggled to recover after the 2020 market crash obliterated its value. But is the underlying business sound? James Reynolds shares his thoughts.

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The announcement of full-year results by Rolls-Royce (LSE: RR) coincided with recent market turbulence. Indeed, the stock dropped 13% in a single day. Investors were alarmed when CEO Warren East said that he will leave the engineering business at the end of 2022 and that revenue may fall as a result of sanctioned Russian airlines. However, after looking at the core business, I’m more certain that a spare £1,000 of mine would be wisely spent on this company. I own shares in this firm already and believe that now is a good time to buy more at this low price. Let’s look at it more closely.

Recent results

The full-year figures for calendar year 2021 were just released by Rolls-Royce. As a present shareholder, I was glad to see the company turn in a £513m profit instead of a £1.97bn loss as in 2020. This indicates a significantly enhanced operational environment. Indeed, cash outflow for the period plummeted from £4.18bn to only £1.44bn. This is an indication that Rolls-Royce’s stock is levelling out.

In addition, in 2021 the company sold several enterprises, including AirTanker Holdings and ITP Aero, resulting in estimated revenues of roughly £2bn. This might help the corporation pay down its £7.88bn debt load.

Why are Rolls-Royce shares so cheap?

We can better grasp if a company is undervalued or overpriced by looking at its price-to-earnings (P/E) ratio. Based on expected profits, Rolls-Royce has a forward price-to-earnings ratio of 22.27. When compared to two key competitors, Safran and General Electric, which register 29.85 and 27.86, respectively, Rolls-Royce shares could be undervalued. 

Deutsche Bank‘s price estimate of 130p has been confirmed. And Berenberg also set a ‘buy’ rating with a target price of 160p this month. With the shares presently priced at 101p, I believe the Rolls-Royce stock price can continue to rise.

That said, it’s important to note, that subsequent pandemic variants might put a stop to the company’s comeback.

Sustainability at its core

Rolls has suffered a lot during the pandemic as airlines have stayed on the ground. But crucially, the firm’s focus for technological development and investment of late hasn’t been all about airline engines. It’s also been about fossil fuel energy alternatives — notably nuclear. The Qatar Sovereign Wealth Fund invested £85m in the company’s plans for Small Modular Reactors (SMRs) in December 2021. These will generate electricity using nuclear energy and should be connected to the grid by 2030.

And in its core air travel category, in November 2021, the company was also testing electric planes to help transition the aviation industry to cleaner energy sources. These studies were conducted in tandem with engine testing using 100% sustainable aviation fuel. This would be a significant step toward decarbonising the sector.

With recent results, I’m more hopeful that Rolls-Royce stock will recover and I’ll be adding more to my portfolio.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

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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