Does another ratings upgrade set the stage for further Rolls-Royce share price gains?

Rolls-Royce’s recent upgrade consolidates its position in the elite investment grade of companies, so will it help drive its share price still higher?

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Image source: Rolls-Royce 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.

A key potential driver for further rises in Rolls-Royce’s (LSE: RR) share price was re-emphasised to me on 21 August. It was another upgrade in the firm’s credit rating – by Standard & Poor’s (S&P) — to BBB from BBB-.

Credit ratings are overlooked by many investors, in my experience. However, they are as crucial to a company’s future financial prospects as they are to an individual’s.

For both, they dictate how much credit can be accessed and at what cost. They also influence how willing financial institutions are to discuss future opportunities for either.

Should you invest £1,000 in The Gym Group Plc right now?

When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if The Gym Group Plc made the list?

See the 6 stocks

In the top tier of global companies

All companies are ranked according to their overall creditworthiness by the world’s rating agencies. These range from levels of ‘speculative’ quality at the bottom to degrees of ‘investment’ quality at the top.

S&P had already increased its ranking for Rolls-Royce to investment grade earlier this year. The other two major global ratings agencies – Moody’s, and Fitch – also promoted it to that level in the past year or so.

This latest upgrade underlines that the company is consolidating its position in this most rarefied of credit rating brackets.

At its Capital Markets Day on 28 November last year, Rolls-Royce highlighted the securing of this top ranking as a key to its future growth.

What will this growth look like? 

The firm committed back then to three broad strategies to be achieved by 2027. First, to become a high-performing, competitive, and resilient business. Second, to grow sustainable cash flows. And third, to build a strong balance sheet and to increase shareholder returns.

More specifically, it is targeting an operating profit of £2.5bn-£2.8bn, an operating margin of 13%-15%, and a return on capital of 16%-18% by that point. It also aims for free cash flow of £2.8bn-£3.1bn by then.

These targets imply significant growth from now, reflected so far in very strong full-year 2023 results and H1 2024 results.

Do these figures look realistic?

The major risk to Rolls-Royce in my view is that the pace of expansion puts a strain on its production capabilities. In fact, Airbus stated on 25 June that Rolls-Royce engines for its A330neo were behind schedule.

Repeated comments of this nature would damage the firm’s reputation and ultimately damage sales prospects.

That said, as of 21 August, S&P believes Rolls-Royce’s prospects are at least as good as the firm itself thinks.

The ratings agency expects adjusted EBITDA margins at 18%-19% in 2024 and 2025, and free operating cash flow of £2.1bn-£2.3bn in the same years.

It also expects the balance sheet to keep strengthening, with adjusted debt-to-EBITDA remaining well below 1.5 times in 2024-2025. This debt level is considered healthy for firms in its sector.

What is a fair value for the shares?

On the key price-to-earnings (P/E) stock valuation measurement, Rolls-Royce trades at 18.1.

This is at the bottom of its peer group, which averages a P/E of 34.6.

discounted cash flow analysis shows the stock to be 57% undervalued at the present price of £4.97.

Therefore, a fair price for the stock would be £11.56, although it may go lower or higher than that.

Created with Highcharts 11.4.3Rolls-Royce Plc PriceZoom1M3M6MYTD1Y5Y10YALL2 Sep 20192 Sep 2024Zoom ▾Jan '20Jul '20Jan '21Jul '21Jan '22Jul '22Jan '23Jul '23Jan '24Jul '242020202020212021202220222023202320242024www.fool.co.uk

If I did not already own other shares in the same sector, I would buy Rolls-Royce today for this extreme undervaluation and exceptional growth prospects.

Should you buy The Gym Group Plc now?

Don’t make any big decisions yet.

Because Mark Rogers — The Motley Fool UK’s Director of Investing — has revealed 5 Shares for the Future of Energy.

And he believes they could bring spectacular returns over the next decade.

Since the war in Ukraine, nations everywhere are scrambling for energy independence, he says. Meanwhile, they’re hellbent on achieving net zero emissions. No guarantees, but history shows...

When such enormous changes hit a big industry, informed investors can potentially get rich.

So, with his new report, Mark’s aiming to put more investors in this enviable position.

Click the button below to find out how you can get your hands on the full report now, and as a thank you for your interest, we’ll send you one of the five picks — absolutely free!

Grab your FREE Energy recommendation now

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.

Simon Watkins 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

Investing Articles

See what £10,000 invested in Tesla shares at their mid-December peak is worth today 

As the world absorbs the full scale of Donald Trump's tariffs, Tesla shares are reeling. Investors who bought the stock…

Read more »

Hand flipping wooden cubes for change wording" Panic " to " Calm".
Dividend Shares

2 ‘safe’ LSE dividend stocks to consider as global markets sell off

As global markets experience high levels of volatility due to economic uncertainty, investors are piling into these ‘safe-haven’ dividend stocks.

Read more »

Investing Articles

US stock market rout: an unmissable opportunity for investors?

His tech-heavy portfolio has been smashed by Trump’s tariffs. However, Dr James Fox believes there could be some opportunities in…

Read more »

Investing Articles

After a 13% ‘Trump tariff’ fall, is the Barclays share price too cheap to miss?

Does the Barclays share price fall mean we should all panic and run screaming from the stock market? Nah, of…

Read more »

Mature Caucasian woman sat at a table with coffee and laptop while making notes on paper
Investing Articles

2 investment trusts to consider for a Stocks and Shares ISA

These two investment trusts have a different focus -- but our writer sees both as worth considering, one more for…

Read more »

Investing Articles

Deutsche Bank reiterates Buy rating on 9.6% yielding FTSE 250 stock that was “most shorted in UK”

Our writer investigates why a major broker remains optimistic about a FTSE 250 stock that was once the most shorted…

Read more »

Investing Articles

2 things to remember when stock markets are turbulent

US trade policy has rattled the stock markets in New York, London and elsewhere. Our writer outlines a couple of…

Read more »

Investing Articles

Are Trump’s tariffs a once-in-a-lifetime chance for ISA investors to get rich?

The £20,000 Stocks and Shares ISA limit will reset on 6 April. Smart investors could use current market volatility to…

Read more »