The Rolls-Royce (LSE:RR) share price has risen an impressive 63% since the beginning of 2023. But in recent weeks the engineer’s ascent has stalled as worries over the global economy have resurfaced.
It’s possible that the FTSE 100 company is just pausing for breath before another charge higher. The cheapness of its stock (at least on paper) could certainly attract fresh interest from value investors before too long.
At 154.6p per share Rolls-Royce shares trade on a forward price-to-earnings growth (PEG) ratio of 0.2 times. A reading below 1 indicates that a stock is undervalued.
Is now the time for me to buy the firm’s shares for my portfolio?
The rebound continues!
The rebound in Rolls-Royce’s share price has been driven by the airline industry’s post-Covid recovery. The company’s Civil Aerospace division is its single-biggest unit by revenues, and organic sales here jumped 25% in 2022.
Aircraft servicing revenues leapt as large engine flying hours jumped 35% year on year. Flying hours were still only at 65% of pre-pandemic levels, but a raft of positive airline updates suggest that they will keep rising sharply.
News this week of “high levels of demand and strong bookings” at easyJet shows that industry momentum remains strong. The airline even hiked its full-year profits forecasts following recent trading.
Investor confidence in Rolls is also rising thanks to the healthy conditions in the defence market. Military spending is picking up as worries in the West over Chinese and Russian foreign policy grow.
Fellow engineer Senior’s market update on Thursday provided a useful idea of where Rolls is today. The firm — which also supplies technology to airlines and armed forces — said that the “strong commercial aerospace” recovery keeps rolling on. Sales at constant currencies were up 16% in the first quarter.
Why I’m avoiding Rolls shares
Having said all that, I still have large concerns about buying Rolls-Royce shares for my portfolio.
I expect sales to military customers to remain robust in the short-to-medium term. But I’m not convinced that revenues at its Civil Aerospace division will keep charging higher.
Big questions remain over how sustainable the rebound in travel demand really is. Speculation abounds that robust ‘revenge spending’ for plane tickets following the end of Covid-19 lockdowns could peter out suddenly. Persistently high inflation could worsen any slowdown as consumers scramble to save cash.
At the same time, Rolls’ profits are in danger as supply problems persist and cost inflation remains elevated. Senior said today that it remains “mindful of the ongoing supply chain pressures in aerospace.”
I’m also put off by Rolls’ high net debts of £3.3bn. The cost of servicing its borrowings is huge and looks set to grow further as interest rates continue to rise.
What’s more, these debts could significantly hamper the firm’s ability to fund its highly expensive development programmes. This in turn could affect its ability to win future business against competitors.
So for the time being I’m happy to ignore Rolls-Royce’s cheap share price. I’d rather invest in other value stocks right now.
