Why the Rolls-Royce share price could be at a turning point

The Rolls-Royce share price has suffered since February. Roland Head explains why he’s looking at the engine specialist as a long-term buy for his portfolio.

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Inside the Rolls Royce Trent 800 Engine, this engine is designed for Boeing 777 aircraft.

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Key Points

  • As an essential supplier to airlines, Rolls-Royce could outperform airline stocks
  • City analysts are relatively upbeat about its prospects
  • Rolls-Royce shares look decent value to me based on medium-term forecasts

The Rolls-Royce (LSE: RR) share price has delivered repeated false starts since the start of the pandemic. I’ve lost count of the number of times the stock has slipped below 100p as investors have rushed for the exits (again).

However, despite the impact of the war in Ukraine, I think Rolls-Royce may finally have reached a turning point. Here, I’ll explain why I’m considering this FTSE 100 stock as a potential buy for my portfolio.

One big change

Restrictions on using Russian and Ukrainian air space are expected to add expensive extra miles to many airline routes. This could slow down a recovery.

But unless the worst happens and the war spreads, I don’t think this regional crisis will prevent a wider recovery in air travel. History suggests to me that airlines and passengers will soon learn to fly around this terrible situation.

For me, the key story right now is that the pandemic is coming to an end. Covid-19 travel restrictions are gradually being lifted.

I’d hope that from now on, the airlines and suppliers such as Rolls-Royce will only have to handle normal problems, such as energy costs and recessions.

Unlike the pandemic, these challenges are business-as-usual for the aviation industry.

Rolls-Royce vs airline stocks

I don’t think airlines are out of trouble just yet. To protect their route networks and their share of the market, I think airlines will have to start flying regular schedules even if they’re not filling every plane.

I expect ticket prices to stay reasonably competitive too, despite rising fuel costs and the need to fly extra miles around Russia.

In my view, the UK’s big airlines have the financial strength to survive and return to profitability. But I think that Rolls-Royce is likely to do better. This FTSE 100 group is an essential supplier to airlines all over the world. The maintenance contracts on Rolls-Royce engines are based on flying hours.

As long-haul aircraft start flying more regularly, airlines will start receiving bigger bills from Rolls-Royce. This is one cost that can’t be cut.

Rolls-Royce share price: firm support

I’m not the only one who thinks this way. City analysts covering Rolls-Royce may have cut their forecasts since Russia invaded Ukraine, but they’re still forecasting a steady recovery.

Famed growth investor Jim Slater once said that investors shouldn’t buy into a turnaround stock until forecasts showed a recovery in profits. Broker estimates show Rolls’ after-tax profit rising from £383m in 2022 to £805m in 2024.

These numbers won’t be exactly right. But they put the stock on a forecast price/earnings ratio of 21, falling to a P/ E of 11 in 2024. That looks affordable to me. Alongside this, debt is expected to fall. I estimate this could open the door to a dividend in 2024.

Rolls-Royce still faces headwinds from reduced demand and the challenges of net zero. But this group is a key supplier to many airlines and has valuable technology.

On a long-term view, I think these advantages will support a steady recovery for Rolls-Royce. At the current share price, I’d consider shares as a long-term buy for 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.

Roland Head 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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