Rolls-Royce Holdings (LSE: RR.) shares have had a great year, after a swing back to profit in 2022. Well, an operating profit at least, but that’s still big news.
We also saw the free cash flow that the board has talked of all year, sitting at £505m.
But has the share price gone too far? Well, even after a 70% climb in the past 12 months, it’s still down 45% in five years.
But a few things make me think Rolls-Royce shares could have a fair bit more to give. First up, that cash flow makes a huge difference.
Cash flow
It ends fears of how much more cash the firm might bleed before it stems the flow. And we can now think about profit gains in the next few years instead.
That should lead to a share price re-rating. And it has done, to some extent. But I think there could be more to come.
The next point brings risk too, and that’s debt. But the good news is that Rolls knocked a huge £1.9bn off it in 2022. If we see more of the same this year, the shares could gain some more. And the cash flow is there to help it.
The bad news is that there was still £3.3bn of net debt at the end of 2022. And much of the year’s fall was paid from disposals, which can’t go on every year.
Fair value?
Debt has to be the main risk now, as it throws off the valuation. We’re looking at a fairly high price-to-earnings (P/E) ratio, up at 30 for this year.
Forecasts see it cut in half by 2025, and I think a P/E of 15 would be cheap… with no debt on the books. With debt, I’m not so sure.
Then again, some firms go for years with big debts. If they can generate the cash to service it, to grow, and to pay dividends, it can all be fine. Still, Rolls does aim to get it down some more, and I like that.
Maybe the valuation is a fair one. And it’s always better to buy a great company at a fair price than a poor one on the cheap. Someone famous once said that!
Dividends back
I mentioned dividends. And yes, Rolls is lined up to pay them again. There won’t be much for at least a year or two, with the 2025 yield put at just a bit more than 1%.
But it’s a good start. And if folks see dividends as here to stay, they could push the shares up a bit more.
Then we’re looking at planes getting back in the air, and people round the world jetting away again. The long-term prospects there could be another trigger.
So yes, I do see a few things that make me think Rolls-Royce shares have a good future now. But there are still the risks, mainly that debt. And until the unknowns clear a bit, I think we might see some dips in the short term.
But that could mean more chances to buy cheap shares.
