Rolls-Royce (LSE:RR) shares have outperformed the FTSE 100 by some margin over the last year. The stock is up a phenomenal 83%. However, this belies a long-term move lower. A decade ago, the aerospace giant traded for nearly £4.50 — more than three times the current spot price.
If the company had grown at a steady 5% a year over the last decade, today it would be worth £7.41 a share. But instead, partly due to the pandemic, the share price has gone the other way. Today, we can snap up shares for just £1.47.
So, this leads me to ask, will Rolls ever be the darling of the FTSE 100? Could it hit £10 a share?
Returning to the black
Rolls suffered during the pandemic as flying hours — the main revenue source across its three biggest business segments — tanked. Finally, things are looking up, the aviation sector is booming, but Rolls’ defence and power systems businesses are also performing well.
Collectively, this should contribute to a long-awaited set of positive results come the end of the year. If we’re lucky, we may see a dividend for the first time since the start of the pandemic. The latter could engender a big jump in the share price.
Valuation
Rolls currently trades around 77 times earnings — that’s obviously expensive but it reflects that this is a company in recovery mode. A decade ago, when its valuation was approximately three times higher, the company traded for around 18 times earnings.
The thing is, we don’t know how profitable the new leaner Rolls really is in this post-pandemic world. The company is forecasting free cash flow guidance of £600m-£800m for 2023, but this just gives us an idea of what net income will look like for the year.
Using the historic price-to-earnings of 18, earnings of around £650m would satisfy the current share price. Earnings could feasibly double from there on, reaching levels similar to 2016/17.
A growth stock?
Using the same formula, Rolls would have to register net income around £3.5bn for the company’s valuation to reach somewhere near £10 a share. That’s clearly not on the cards anytime soon. But the technologies it’s developing could be the key to greater profitability going forward.
A decade ago, my colleague Royston Wild suggested that Rolls was an “excellent growth stock“. The promised growth didn’t happen then, but I’d say the same growth potential remains today. Rolls is testing cutting edge technologies, and not just within its core business segments.
The British engineering giant is looking to make technologies like modular nuclear reactors, carbon-capture, and electric air travel commercially viable. Of course, these technologies might come to nothing. But the odds are, one of them will become another revenue-generating business unit in the future.
Rolls may be taking a step back from carbon capture, but I believe there is huge potential in these pipeline technologies. For me, it’s a value pick with huge growth potential. I certainly believe we could see Rolls at £10 one day. And if it does get there, innovation will be the reason.
