Why the Rolls-Royce share price could continue to outperform

The Rolls-Royce share price keeps moving forward, but this Fool thinks it’s still behind where it ought to be after the company’s latest update.

| More on:

Image source: Rolls-Royce Holdings plc

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Let there be no suspense – I think the Rolls-Royce (LSE:RR) share price looks like a bargain, even after a 197% increase over the last year. And last week’s news seemed to confirm this. 

The company announced engine flying hours are back to their 2019 levels and reiterated its targets for this year. The stock didn’t react, but I sense the market’s making a mistake. 

The bull case

I believe the bull case for Rolls-Royce shares has been the same for some time. The company’s aiming to achieve £3.1bn in free cash flows by 2027. 

Put simply, I think the stock’s a great value if the underlying business can achieve this. The firm has a market-cap of £37bn, which means £3.1bn a year amounts to an 8.3% return.

That’s about double the return offered by a 10-year UK government bond at the moment. So if things go to plan, the stock will look like a bargain at today’s prices.

Obviously, Rolls-Royce might not hit its targets until 2027 and the stock should reflect this risk. But with things going to plan, I take the view the share price should be higher than it is. 

Trading update

Last week, the company announced that engine flying hours had recovered to pre-Covid levels. And management reiterated its forecasts for the current year. 

Both of these developments are very positive, in my view. The foundation of the recovery in the Rolls-Royce share price has been a return to pre-pandemic demand for flying. 

This has set the company off on a virtuous cycle. Higher free cash flows have led to lower debt, which has reduced interest payments, leading to higher free cash flows – and so on.

All of this has been propelling the stock higher and the latest update indicates that things are going well. The share price however, was largely unmoved by the latest news. 

Optimism

I’ve been seeing reports that the number of engine flying hours was expected to come in even higher than it did. That probably explains the market’s subdued response.

As I see it, the company being on track is absolutely fine given its stated targets and the current level of the stock. But it does point towards a genuine risk with the business.

If travel demand does start to weaken, Rolls-Royce might find its growth slows significantly. And that could jeopardise the 2027 target that the bullish thesis is built on. 

A rising cost of living makes it impossible to eliminate this risk entirely. But that’s why I think the latest update reiterating that things are on track is a significant positive.  

Still a bargain?

At today’s prices, I don’t believe Rolls-Royce needs to to anything spectacular for the stock to be good value. It just needs to stay on track to meet its medium-term targets. 

Each time the company reports this is the case, I think the risk with the stock goes down and the share price should go up. Whether it’s the best FTSE 100 stock to buy right now is another question, but I certainly expect it to outperform the index.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Stephen Wright has no position in any of the shares mentioned. The Motley Fool UK has recommended Rolls-Royce Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Newspaper and direction sign with investment options
Investing Articles

Huge gains and 9% yields: why now’s an amazing time to be a stock market investor

The stock market’s generating fantastic returns in 2024. Whether you're looking for gains or income, it’s a great time to…

Read more »

Hand of person putting wood cube block with word VALUE on wooden table
Investing Articles

This steady dividend payer looks like one of the best bargain stocks in the FTSE 100

A yield of 4.7% and a consistent dividend record make this FTSE 100 company look like good value in an…

Read more »

Young mixed-race couple sat on the beach looking out over the sea
Investing Articles

£9,000 in savings? That could become passive income of £19,175 a year

It's possible to invest affordable sums of money into building a big passive income stream. Here's how I'd go about…

Read more »

Black father and two young daughters dancing at home
Investing Articles

Legal & General shares: a once-in-a-decade passive income opportunity?

Is a dividend yield at its highest level in a decade, combined with a strong record of increasing payouts, a…

Read more »

Investing Articles

With a 7% yield and 4.1 P/E, is this the best passive income stock on the FTSE 350?

Millions of Britons invest for a passive income. While our writer isn't buying this stock yet, he believes it's worth…

Read more »

Middle-aged Caucasian woman deep in thought while looking out of the window
Investing Articles

This amazing FTSE 250 has a 8.8% dividend yield and trades at just 4x forward earnings!

Our Foolish writer believes this FTSE 250 stock is worth keeping a very close eye on. However, he's not keen…

Read more »

Portrait of elderly man wearing white denim shirt and glasses looking up with hand on chin. Thoughtful senior entrepreneur, studio shot against grey background.
Investing Articles

Could this brilliant airline stock be the most undervalued company on the FTSE 100?

Our writer believes this FTSE 100 stock may provide market-beating returns over the coming years, noting its undervalued metrics and…

Read more »

Young black colleagues high-fiving each other at work
Investing Articles

The Rolls-Royce share price is discounted by 13.4%, analysts say

Our writer explains why analysts think the Rolls-Royce share price is lower than it should be, noting long-term earnings growth…

Read more »