Is the Rolls-Royce share price a bargain?

Is the Rolls-Royce share price a bargain? The company is profitable again, but its debt might be too much for our author to think it’s worth investing in.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Smartly dressed middle-aged black gentleman working at his desk

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Despite a recent rally, the Rolls-Royce (LSE:RR) share price is 40% lower than it was at the start of the year. But with the company turning profitable again, is the stock a bargain?

According to Warren Buffett, the amount a company’s stock is worth comes down to the amount of cash it will produce over time. So let’s see how Rolls-Royce stacks up by these metrics.

Cash generation

The Rolls-Royce share price currently values the entire business at around £6.45bn. Last year the company generated £450m in free cash.

That’s a return of just under 7%, which I think is fairly attractive. But the situation isn’t straightforward.

Rolls-Royce also has quite a lot of debt. According to its most recent accounts, the company’s total debt stands at just over £7.7bn.

Too much debt can make a business significantly less attractive from an investment perspective. The more a business has to spend on its debt, the less it can return to its shareholders.

I think that the Rolls-Royce debt is a significant issue for two reasons. The first is the amount of debt the company has and the second is the interest the company has to pay on it.


With £7.7bn in debt, buying Rolls-Royce shares today means taking on debt worth more than the price of the shares. That’s not always a problem, but it needs to be accounted for in an investment decision.

Adding the company’s debt to the price of its shares gives a total cost of around £14bn for the company. And at those prices, a £450m revenue only amounts to a 2.5% return, which is much less attractive.

The other issue is that Rolls-Royce has to pay interest on its debt. At the moment, almost half of the company’s operating income is spent on interest payments.

I think that’s a lot. For context, BAE Systems spends about 20% of its operating income on interest payments, and Halma and Renishaw each spend less than 1%.

Paying too much in interest makes it difficult for Rolls-Royce to bring its overall debt down. That might not be an immediate problem, but I see a significant long-term risk here.

With interest rates rising, I think that the amount that Rolls-Royce pays on its debt is going to increase. And this will make it harder for Rolls-Royce to lower its overall debt.

Is the stock a bargain?

Based on the amount of cash the business generates, Rolls-Royce shares look cheap to me at the moment. But the amount of debt on the company’s balance sheet also makes the stock look risky.

I’m concerned that rising interest rates will get in the way of the company’s ability to generate strong cash returns in the future. As a result, I’m inclined to look for other opportunities.

There’s definitely scope for the business to do well in the future and if the company can clear its debts, then I think that the stock can easily double. But at the moment, the risk outweighs the reward for me.

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.

Stephen Wright has positions in Halma. The Motley Fool UK has recommended Halma and Renishaw. 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.

More on Investing Articles

Close-up of British bank notes
Investing Articles

£8 per year in extra income for life, for each £100 invested today? Here’s how!

Christopher Ruane explains how he would aim to set up extra income streams for the rest of his life by…

Read more »

Photo of a man going through financial problems
Investing Articles

With a £20K Stocks and Shares ISA, I’d target £1,964 in annual dividends like this

With an annual passive income target close to £2,000, our writer explains how he'd put a £20K Stocks and Shares…

Read more »

Illustration of flames over a black background
Investing Articles

Down 63% in 2024, what’s going on with the Avacta (AVCT) share price?

2024 has been a difficult year for many companies in the biotechnology sector, with the AVCT share price down heavily.…

Read more »

Warren Buffett at a Berkshire Hathaway AGM
Investing Articles

Here’s how I’d invest £800 the Warren Buffett way!

Christopher Ruane learns some lessons from super-investor Warren Buffett he hopes could improve his own stock market performance.

Read more »

British Isles on nautical map
Investing Articles

Michael Burry just bought 175,000 shares in this FTSE 100 company

Scion Asset Management announced a $6.5bn stake in BP this week. But what could Michael Burry be seeing in an…

Read more »

Young Asian woman holding a cup of takeaway coffee and folders containing paperwork, on her way into the office
Investing Articles

£5,000 in savings? Here’s how I’d aim to start making powerful passive income today

With a cash lump sum to invest, this Fool lays out how he'd start making passive income. He also details…

Read more »

Investing Articles

Just released: our 3 top small-cap stocks to consider buying before June [PREMIUM PICKS]

Small-cap shares tend to be more volatile than larger companies, so we suggest investors should look to build up a…

Read more »

Passive income text with pin graph chart on business table
Investing Articles

My best FTSE 250 stock to consider buying now for passive income while it’s near 168p

This is a rare stock with a growing underlying business and a fat dividend yield – it’s worth consideration for…

Read more »