The Rolls-Royce (LSE:RR) share price has rocketed in 2023. Even as the broader FTSE 100 experienced turbulence in March, the engine maker’s price remained robust.
Since 1 January Rolls-Royce shares have risen an impressive 61% in value. And yet, at least at first glance, the company still looks like one of the UK’s best blue-chip value stocks.
City analysts expect annual earnings to soar 156% in 2023. This leaves the business trading on a forward price-to-earnings growth (PEG) ratio of just 0.2.
Any reading below 1 indicates that a stock is undervalued.
Growth, value, AND income
Rolls-Royce shares clearly give growth and value investors something to get excited about. Yet brokers also suggest that the engineer could also be a great dividend stock to buy today.
This is because the business — which hasn’t paid a dividend since 2019 — is tipped to restart its payout policy from this year.
Okay, a projected 1.63p per share dividend for 2023 isn’t the biggest. In fact this sits at a 1.1% dividend yield, well below the 3.6% FTSE 100 average.
Yet predictions of strong dividend growth still make Rolls-Royce shares worth considering for passive income. In 2024 the total payout is predicted to jump 81% year on year to 2.95p.
A bright outlook
City experts predict that its profits will grow strongly over the next few years. This is predominantly due to the rebound in civil aerospace activity that is, in turn, supercharging demand for the engineer’s aftermarket services.
The International Civil Aviation Organization (ICAO) has predicted that passenger demand “will rapidly recover to pre-pandemic levels on most routes by the first quarter,” illustrating the bright outlook for airlines and aerospace businesses.
It reckons, too, that total passenger demand will rise 3% year on year in 2023.
A healthy civil aviation market is critical for Rolls. It generates around 45% of revenues from building and servicing plane engines.
Things are also looking very healthy elsewhere. New contracts continue to stream in at Rolls’ Defence division. And the order book at its Power Systems unit sits at all-time highs.
Debt problems
Having said all this, I’m not prepared to buy Rolls-Royce shares today. My chief concern is the size of the company’s debt pile.
Net debt stood at £3.3bn as of the end of 2022. And the business could struggle to pay this down if market conditions suddenly worsen again.
Plane ticket sales could weaken again if higher-than-normal inflation persists and economic conditions remain tough. On top of this, profits at Rolls may suffer if supply chain problems and high cost inflation continue.
Here’s what I’m doing now
Such high debts cast a shadow over how Rolls-Royce will finance its cash-intensive development programmes.
Designing and building plane engines, nuclear reactors and other complex hardware doesn’t come cheap. And having a lower budget to operate on compared to rival companies could significantly compromise profits growth.
Future dividends might also be compromised because of this blend of high bills and big debts. So I certainly wouldn’t buy Rolls shares for passive income.
The company’s recovery could well continue into 2023. But on balance I’d rather buy other cheap dividend-paying stocks right now.
