It’s been a wild ride on the FTSE 100 so far in 2023 for many UK shares. Rolls-Royce (LSE:RR) is one UK blue chip whose share price has grabbed the headlines in the year to date.
At 149.8p per share, the engineer has increased in value by 58% since 1 January. It’s risen thanks to a constant stream of good news from the global airline industry.
Yet, at current prices, Rolls-Royce shares still look undervalued on paper. They trade on a forward price-to-earnings growth (PEG) ratio of 0.2. A reminder than any reading below one indicates that a stock is undervalued.
So is the engineer the FTSE 100’s best value stock? And should I buy it for my portfolio today?
Strong momentum
Robust pent-up travel demand is helping airlines bounce back from the depths of the pandemic. An increase in air traffic means that demand for Rolls’ aftermarket services is also rebounding strongly. It also means that orders for plane engines is heating up as airlines ramp up orders of new aircraft.
The strength of the industry recovery has even taken the International Air Transport Association (IATA) by surprise. This week the trade body predicted near-record airline revenues of £803bn in 2023, up 9.7% year on year.
The IATA’s bullishness is understandable given that trading activity across the industry continues to impress. In recent sessions, UK-listed Wizz Air and Ryanair have both released positive market updates. The former carried 51.1m passengers in the 12 months to March, up 88% year on year. Meanwhile its Irish competitor reported a 10% lift in passenger numbers in May.
Rising danger
It’s perhaps no surprise then that City analysts expect earnings at the engine-builder to continue soaring. The business is tipped to follow growth of 156% in 2023 with rises of 51% and 26% in 2024 and 2025.
However, these bright forecasts are under increasing jeopardy as the world economy struggles for traction. The World Bank expects global growth to slow to just 2.1% in 2023 from 3.1% last year.
A combination of ‘sticky’ inflation and rising interest rates casts a cloud over the economic landscape. And it could weigh on plane travel in the latter half of the year and beyond. Beyond this, supply chain problems, staff shortages, and strike action in key markets could dampen travel activity as well.
This all explains why Rolls-Royce’s share price has remained largely flat since early March.
Debt worries
This is a concern given the company’s large debts. Okay, improving revenues, unit disposals, and streamlining efforts all pushed the company’s net debt much lower in 2022. It dropped to £3.3bn in December from £5.2bn a year earlier.
But debt remains uncomfortably high and could limit its ability to fund its growth programmes. What’s more, as interest rates steadily rise, the cost of servicing this enormous debt is stepping higher too. All of this also casts a shadow over when the company will begin paying dividends once more.
As I say, Rolls shares look extremely cheap on paper. But I believe there are much stronger FTSE 100 stocks that I should snap up right now.
