Rolls-Royce (LSE:RR.) shares have soared by around 97% in the last six months. Bumper share price growth has been fuelled by the airline industry’s robust post-pandemic recovery.
As a result, Rolls-Royce is one of the best-performing FTSE 100 stocks of late. But despite this, I think its shares could still be undervalued.
After all, the company trades on a forward price/earnings-to-growth (PEG) ratio of approximately 0.2.
A PEG below one indicates a company’s shares could be a bargain. This is because the P/E is low in relation to its expected growth.
So, would I be foolish to pass up on a potential opportunity to buy cheap Rolls-Royce shares for my portfolio? Let’s take a look.
The long road back to pre-pandemic performance
Simply put, the UK-based engineering company produces aeroplane engines for large long-haul planes.
A substantial amount of its revenue comes from servicing these engines, with business based on how many hours the engines spend in the air.
While analysts have pointed out that so-called engine flying hours (EFH) were up 35% this year, it’s worth noting they’re still only at 65% of 2019 levels.
As such, I reckon it’ll be at least another few years before Rolls-Royce sees EFH back up to pre-pandemic heights.
An improving financial outlook
In February, the company’s full-year results told a story of recovering demand, higher profit, and stronger cash flows.
Underlying operating profit rose to £652m, which is £238m higher than the previous year. The increase was largely driven by the company’s civil aerospace and power systems segments.
Crucially, net debt fell from £5.2bn at the end of 2021 to £3.3bn. This was thanks to a combination of disposals and improved cash flow.
Tranformation underway
Looking ahead, I’ll be keeping a close watch on the implementation of the company’s ambitious transformation programme. Its aim is to succeed in creating a high-performing, growing, and competitive business.
In preparation for the programme, Rolls-Royce benchmarked its performance against peers. I wasn’t surprised to hear the copmany found significant scope to deliver materially higher profit, cash flows, and returns.
As a result, bosses hope that, through the transformation plan, a stronger business with a clear proposition for investors based upon delivering will be created.
To buy or not to buy
In March, UBS upgraded Rolls-Royce from ‘neutral’ to ‘buy’, stating that the company’s shares were “abnormally cheap”.
Considering the company’s share price currently sits around the 150p mark, the Swiss bank’s price target of 200p represents a clear expectation of future growth from certain analysts.
A positive development in this regard came with the recent announcement that Rolls-Royce will provide reactors for Australia’s nuclear powered submarines. This comes as part of the AUKUS trilateral agreement.
It’s news like this that makes me confident in thinking Rolls-Royce shares offer significant value at their present valuation.
While I’d brace for turbulence in the short run, it looks to me like the worst could be over for Rolls. As such, if I had some spare cash lying around, I’d happily hoover up some shares and hold them for the long term.
