Over the past year, Rolls-Royce (LSE:RR) shares have dipped below 100p on a few occasions. Historically, any move below this level has seen buyers come in. This has meant that it hasn’t remained below this point for a long period of time. One the other hand, moves above 120p and 130p also haven’t managed to stick. So as a potential investor, is 20%-30% my highest likely return here, or could it break above the 12-month high of 150p?
Finding a spark to light a fire
It’s clear to me that there’s lot of interest from potential bidders waiting in the wings. One example of this was seen last week. On just a rumour of a potential takeover, Rolls-Royce shares jumped 19% in a day.
Given the golden share that the UK Government owns, it would be unlikely that it would approve a foreign company buying Rolls-Royce just due to the security implications. Yet despite this (and the lack of concrete information) the share price still jumped significantly.
What this shows to me is that if we get a positive catalyst to jumpstart a rally, I think momentum could quickly take the price higher. This would then allow the market capitalisation to catch up with the enterprise value. That enterprise value includes the market cap, plus any debt and cash it has and is a separate way of valuing a company. Currently, it sits at £13.79bn versus the market cap of £8.57bn.
The 61% jump to reach the enterprise value is an initial level that would suggest a fairer value for the Rolls-Royce share price. Then if quarterly results build on the 2021 figures, an uplift in the enterprise value again could be what’s needed to reach new 12-month highs.
Building on results for 2022
Another reason for optimism is around the results that were released in February. The business bounced back from the operating loss of almost £2bn in 2020 to post a profit of £513m in 2021. What encouraged me was how the different divisions helped to diversify the profit/loss. For example, even though Civil Aerospace continued to struggle last year (posting a loss of £172m), it was offset by profits from Defence and Power Systems.
For 2022, if the Civil Aerospace division can recover and post the profit of £44m seen in 2019, this would boost overall operating profit by a generous 42%. This assumes other divisions perform in the same way as 2021.
On that basis, the Rolls-Royce share price could reflect that uplift via a similar sized jump.
Risks for the Rolls-Royce share price
Despite the reasons for optimism, the chance of it breaking above 150p over the next year isn’t certain. For a start, the company will have to bed in with a new leader. Current CEO Warren East is due to depart at the end of the year. Further, the company still has a swollen amount of debt that will need to be reduced in coming years.
On balance, I do think that there’s a strong chance that Rolls-Royce shares could hit new highs this year. Yet I see it as a risky stock. Therefore, I’d only consider investing an amount that I’d be OK with having to sit on for a while if the share price continued to struggle.
