Over the last month, Rolls-Royce (LSE:RR) shares have enjoyed some long-awaited momentum, rising by an impressive 17% to 92p today. However, even with this upward trajectory, the stock is still trading well below pre-pandemic levels and is down almost 20% in the past 12 months. Yet is this actually a bargain buying opportunity for my portfolio?
The bull case for Rolls-Royce shares
In May, management released a trading update showing some encouraging recovery signs. And this is undoubtedly a primary catalyst for the recent surge in Rolls-Royce shares.
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Flying hours for its large engine service contracts during the first four months of the year are up by a staggering 42%. Beyond being a higher increase than in 2021, it provides further evidence that airline stocks are making their comeback. And with more travel restrictions being either loosened or completely lifted, this trend is unlikely to change.
Meanwhile, progress with the group’s newly established electric and small modular reactors (SMR) division is looking promising. In partnership with Tecnam and Rotax, the group successfully completed a test flight for its first hybrid-electric aircraft.
At the same time, the generic design assessment for its mini nuclear reactors is now underway, bringing them one step closer to powering the British national grid.
With its flagship aerospace division returning to former glory, and long-term projects yielding positive results, Rolls-Royce shares look like they have a bright future. Even more so, given that its power systems and defence segments are holding firm against the headwinds of supply chain disruptions.
Taking a step back
There’s no denying that this business is in a much stronger position than a year ago. But it’s not out of the woods yet. Diving deeper into the details reveals some potential hurdles that management has yet to overcome.
Supply chain disruptions have largely been mitigated so far, thanks to a buffer of raw materials being held in inventory. However, this source of components is finite. And if supply lines remain disrupted for the foreseeable future, fulfilling customer orders could become increasingly challenging. That potentially creates opportunities for its competitors.
The balance sheet also remains in a weak state. This may soon change once the ITP Aero disposal is complete, raising £2bn in cash to wipe out a significant chunk of debt. However, this deal is still subject to regulatory approval which, while I think it unlikely, may not be granted.
A bargain stock to buy now?
From a valuation perspective, Rolls-Royce shares look undeniably cheap, in my eyes. Assuming analyst forecasts for 2023 are accurate, the stock is currently trading at a tiny forward price-to-earnings ratio of 1.6!
Having said that, this may well be a value trap. Even with the various structural changes and cost-saving initiatives, the company still has a long road to refortifying its balance sheet – even with the proceeds from ITP Aero.
Personally, I’m cautiously optimistic about this business. However, with a high level of unknowns still at play, I will stay on the sidelines a little longer.
