Rolls-Royce (LSE:RR) shares are among the most traded on the FTSE 100. To some investors, it’s a clear value pick. To others, it’s an indebted firm with an uncertain future. And this creates volatility.
To put that into perspective, the stock is up 118% over six months, up 44% over a year, and is down 50% over five years.
So what’s next? Is Rolls-Royce still undervalued?
What analysts think
Earlier in March, Swiss bank UBS told investor it thought Rolls shares were “abnormally cheap“.
The bank said: “Even despite the more than 40% share price move since Q4 results Rolls still trades nearly 2pts below its historical yield at circa 9% consensus 2024 estimated free cash flow”.
This was followed by an upgrade, with UBS nearly doubling the price target, to 200p from 105p.
But UBS isn’t the only bank with a positive outlook on the UK engineering giant. Citi lifted its price target on Rolls-Royce in mid-March to 255p as it cited “a clear route to much better cash flow“.
So as Rolls shares pushed above 150p this week for the second time this year, maybe more growth is on the cards.
What could push Rolls up?
The recovery in civil aviation is a major factor that has brought the share price to where it is today. But investors are struggling to grasp how much of a boost this could be.
China’s reopening is another factor within this. That’s because you’re unlikely to find Rolls-Royce engines on flights within Europe. But in China, wide-body planes with two aisles and Rolls-Royce engines are used for short-haul routes.
China, according to UBS, accounted for 40% of wide-body traffic reduction in 2022 versus 2019.
The data has been positive since China’s reopening. In February, passenger traffic increased 38% year-on-year. International passenger traffic increased 756% — although that’s not entirely surprising, given China was locked away from the rest of the world a year ago.
We also know that the other two business segments — power systems and defence — are delivering steady growth.
The biggest concern in debt. Net debt has been significantly reduced, but it’s still a concern at £3.3bn.
Top performer?
There’s a strong chance the company could be the top performer on the FTSE 100 in 2023. After all, it’s had an immensely strong start to the year.
I don’t see too much movement in the share price until we see some more data about the company’s post-pandemic recovery.
However, I’m confident that Rolls’s recovery will continue, with revenue soon to reach 2019 levels, despite being a considerably smaller and leaner company today. I do believe the stock is undervalued.
I have a fairly significant holding in the stock. And on this occasion, I’m actually not buying more. The only reason is because I see greater value in financial stocks at this moment in time — following the collapse — and I’ve got limited capital.
