The Rolls-Royce (LSE: RR) share price continues to rise strongly in the run-up to Christmas. Yet on paper the engineer still offers exceptional value for money.
City analysts think earnings will keep soaring in 2023 and rise 245% year on year. This means Rolls-Royce shares currently trade on a price-to-earnings growth (PEG) ratio of just 0.1.
Any reading below 1 indicates that a stock is undervalued.
Does this make Rolls the most attractive value stock on the FTSE 100 today? And should I buy the recovering business for my portfolio?
The recovery continues
Rolls-Royce shares have been swept higher by a stream of positive updates from the airline industry. Given that the business makes 44% of revenues from engines and aftermarket sales, a strong civil aerospace sector is critical.
Budget flyer easyJet was the latest London Stock Exchange airline to release buoyant trading numbers. Last week it announced record fourth-quarter earnings and a trebling of passenger numbers between July and September.
It also described bookings for next summer as “positive”, painting a bright picture for 2023. Former IAG boss Willie Walsh has built on the sense of optimism in recent days too.
Walsh — who’s currently director general of the International Air Transport Association (IATA) — this week predicted that global airlines would make a profit of $4.7bn in 2023. He added that around 4bn passengers will jet off somewhere next year.
Flying high
So, demand for Rolls-Royce’s aftermarket services could be set to rise further next year. It might also witness a pick-up in engine orders in a boost to its long-term forecasts.
This isn’t the only reason why forecasters think Rolls’ profits will soar though.
Impressive sales momentum at its Power Systems division also looks set to drive the bottom line. The unit enjoyed record order intake between January and October. This was thanks to “high levels of demand in many of our end markets,” the business said.
A risk too far?
Rolls’ turnaround since the depths of the pandemic is encouraging. But I’m not prepared to buy the company’s shares just yet.
Airlines like easyJet could perform solidly in 2023 as budget-conscious travellers opt for cheaper tickets. However, overall airline passenger numbers could slump as economic conditions worsen, hitting demand for the engineer’s aftermarket services.
The company also faces more supply chain problems and inflationary pressures in the New Year. These factors contributed to it swinging to a thumping £1.6bn loss in the first six months of 2022. Supply chain issues are especially problematic for its star performer Power Systems division.
Debt worries
I may be willing to look past these current dangers as a long-term investor, at least if the company had a robust balance sheet.
But Rolls needs to grow profits strongly to pay down its massive debt pile (it had net debt of £5.1bn as of June).
An elevated debt pile could be a huge drag on investment. It could also scupper any plans the business has to restart its dividend programme.
As I say, Rolls-Royce’s share price looks cheap today. But in my opinion its low valuation reflects the risks it continues to pose to investors.
