A year ago, I had a large holding in Rolls-Royce (LSE:RR) shares. And I couldn’t have imagined that the stock would be up 233% a year later.
I had mistakenly sold my holdings throughout the year, and then realised my error, and have since bought in again.
So, the big question is whether the stock can push higher? I think it can.
Positive influences
Looking forward, Rolls-Royce appears strategically poised to benefit from favourable long-term trends that should benefit all three major business segments.
The increasing global tensions, coupled with challenges from resource scarcity and population growth, create opportunities for Rolls-Royce’s expertise in defence technologies.
And this has put Rolls’s defence and power systems at the forefront of NATO’s capability development programmes, from AUKUS submarine engines to aviation propulsion systems.
Moreover, in civil aviation, Rolls-Royce is forecast to benefit from a considerable rise in demand as the global middle class grows over the next two decades.
That’s because Rolls earns money from flying hours — the amount of time their engines are used.
With that in mind, Airbus projects a need for 40,850 additional aircraft by 2042, with 80% being single-aisle planes.
This means the global fleet will require at least 81,700 engines. It’s a huge market.
Rolls-Royce, well-placed to meet propulsion needs for the growing global fleet, should consider adjusting its focus to cater to the rising demand for single-aisle jets.
Traditionally, aircraft manufacturers have used Rolls’ engines in wide-body planes.
Valuation
Rolls is very much a company recovering from the impact of the pandemic, when demand for civil aviation plummeted.
However, the forecast for earnings growth is very strong. In fact, Rolls is currently trading with a price-to-earnings-to-growth (PEG) ratio of 0.51.
This metric is calculated by taking the forward price-to-earnings ratio and dividing it by the earnings per share (EPS) long-term growth consensus estimate — three- to five-year compound annual growth rate (CAGR).
This exceptionally low PEG ratio is made possible for a forecasted long-term growth (3-5Y CAGR) rate of 67.7%.
This is a particularly useful metric for analysing earnings, as it is adjusted for growth.
Rolls actually has the second-strongest PEG ratio on the FTSE 100, behind Tesco.
And it infers that Rolls could be undervalued by half, with fair value sitting just above £6.
Weighing it up
The pandemic highlighted that Rolls is susceptible to major demand shocks. Its defence and power systems segments are fairly robust, but that’s not necessarily the same for civil aviation.
Civil aviation is by far the company’s largest business segment, and despite surging demand for travel, it’s not what you’d call a staple product.
Nonetheless, the forecasts are extremely positive, as are the metrics. That’s why I’m once again very bullish on Rolls-Royce.
