Like billionaire investor Warren Buffett, I love to find shares that offer top value. And on paper, the Rolls-Royce (LSE:RR) share price might appear too cheap for me to miss.
City analysts think earnings here will soar 466% in 2022 as the airline industry rebound continues. This leaves the FTSE 100 engineer trading on a forward price-to-earnings growth (PEG) ratio of 0.3 for 2023. Any multiple below 1 indicates a stock is undervalued by the market.
“A burning platform”
Yet comments reportedly made by Rolls’ new chief executive Tufan Erginbilgic suggest that the business remains on dangerous ground. He’s alleged to have said the company is standing on “a burning platform” and described recent performances as “unsustainable”.
Some stocks trade on low valuations for a good reason. So is Rolls-Royce an investment trap? Or is it one of the best value stocks to buy right now?
Travel recovery continues
As I say, the recovery in air travel fuels the engine builder’s bright profits estimates. However, with travel operators consistently beating predictions with recent trading results, it’s possible Rolls-Royce might actually generate higher-than-expected earnings in 2023.
TUI Travel was the latest to announce blockbuster results last week. It said it has witnessed “significant booking momentum” since October, with booking volumes in the past four weeks having beaten pre-pandemic levels.
The recovery could unravel if the pressure on consumer spending endures, or worsens. This would hit Rolls by damaging airlines’ flying hours and thus demand at its engine servicing division. But, right now, things look good as pent-up travel demand boosts plane ticket sales.
Case for the defence
Things are also looking bright for Rolls-Royce’s defence division. Russia’s invasion of Ukraine means Western governments are likely to hike weapons spending over the next several years, at least.
Meanwhile, worries over China’s foreign policy — which have heightened after the country’s balloons were shot down over the US this month — should also bolster defence budgets.
BAE Systems can also expect hardware sales outside the US and UK to keep rising strongly. Defence spending in emerging markets in particular is soaring as their economies boom.
Last week, the company signed a memorandum of understanding (MoU) with India’s flight simulator manufacturer FTSC to develop new technologies. It also signed an MoU to work on projects with the country’s unmanned flight specialist NewSpace.
Debt concerns
There are good things happening at Rolls-Royce then. But as a potential investor, there are still matters that concern me right now.
First and foremost is the FTSE company’s huge debts. Outstanding drawn debt of £4bn raises some doubt on how it will be able to fund its ambitious growth programmes, like the development of cleaner plane engines. It also casts a cloud on when the business will start paying dividends again and at what levels.
Supply problems
As an investor I’m also mindful of ongoing supply chain and inflation pressures across the aerospace industry. Even as Rolls’ revenues improved in the first half of 2022, the firm swung to a hulking £1.6bn loss on the back of these issues.
It’s true that Rolls-Royce’s share price looks attractive on paper. But, on balance, I’d rather buy other value shares for my portfolio.
