Rolls-Royce (LSE:RR.) shares have been one of the comeback stories of the year. They’ve outpaced the FTSE 100 index by a considerable margin. New boss Tufan Erginbilgic recently told investors that the company’s transformation plan was moving “at pace” after the challenging trading period it endured throughout the pandemic.
Indeed, there’s much to cheer in recent financial results and the firm’s darkest days appear to be in the rear-view mirror. But, after big share price gains, is the stock still good value?
Here’s my take.
A recovery underway
The Rolls-Royce share price surged in February after the firm released excellent results for FY22. It’s encouraging to see the company maintain its FY23 forecast in its first trading update of the year.
The business expects it’ll deliver underlying profit in the region of £0.8bn-£1.0bn. It’s also anticipating free cash flow of £0.6bn-£0.8bn, with most of that coming in the second half of the year.
Consequently, the stock isn’t relinquishing its impressive gains in 2023 so far. However, long-term investors are still nursing big losses. Today, the company’s worth approximately half what it was five years ago with a market cap of around £12bn.
Nonetheless, each of Rolls-Royce’s divisions is exhibiting strength.
In Civil Aerospace, long-term service agreement large engine flying hours reached 83% of 2019 levels in the first four months of FY23. Plus, the business recently secured its largest ever order for Trent XWB-97 engines thanks to a deal with Air India.
In Defence, the company’s benefitting from elevated geopolitical uncertainty. The deepening AUKUS partnership is a key tailwind for the share price. The alliance’s submarine programme will be powered by Rolls-Royce nuclear reactors.
Finally, in Power Systems, the firm’s reaping the rewards of an exceptionally high order intake from the prior year. In addition, Rolls-Royce has indicated margins will improve in the second half of FY23.
Challenges remain
Net debt is one of my biggest concerns. Granted, Rolls-Royce made a huge stride towards repairing its balance sheet last year by reducing the year-on-year net debt figure 36% to £3.3bn by the end of FY22. However, this number still looks high to me and I’m worried the easiest measures have been taken considering much of the reduction came from asset disposals.
In that context, the Sunday Times recently reported that the company plans to cut 3,000 non-manufacturing jobs in its efforts to streamline operations. There’s a risk this could adversely impact the quality of the firm’s output. However, Rolls-Royce remains coy on whether a firm decision has been made.
What’s more, there’s a further headache from a legal complaint made by Indian authorities against Rolls-Royce and BAE Systems. The case rests on historic allegations of criminal conspiracy relating to the procurement and licensed manufacturing of 123 Hawk 115 advanced jet trainers.
I’m holding my shares
I bought Rolls-Royce shares before this year’s big jump. I’m sitting on a tidy profit currently, but I think the stock represents fair value today, so I’ll continue to hold.
There are some key risks facing the company. Accordingly, I won’t be adding to my position until the picture becomes a little clearer. In the meantime, I’m looking at other FTSE 100 shares for bargain investment opportunities.
