The Rolls-Royce (LSE:RR) share price is up 1,285% over the past three years. Having flirted with collapse in 2020 and struggled through to 2023, the aerospace and defence group now commands a market capitalisation above £90bn. Analysts remain largely positive about the outlook, but the latest forecasts suggest any future appreciation will be more measured.
What analysts think
According to data compiled from City 16 analysts, the mean consensus is Outperform. The average price target sits at 1,132p, implying the shares are undervalued by just 4.1%. However, as is often the case, forecasts vary widely.
The most bullish estimate points to 1,440p (+32%), while the lowest sees just 240p (-78%). This would make it the third largest company on the FTSE 100. That wide spread highlights both the optimism around management’s progress and the lingering concerns about execution risks.
So what’s happened to turn this once-struggling company — with a market-cap as low as £6bn-£7bn — into a engineering giant with some analysts suggesting the firm should be worth around £130bn? Well, almost everything has gone in the company’s favour over the past three years with operational efficiency drives complemented by supportive trends in all three of its major segments.
Transformation and valuation
The balance sheet transformation has been dramatic. Net debt, which stood at £5.1bn in 2021, is expected to swing to a net cash position of more than £7bn by 2027. Investors have taken comfort in this deleveraging, as well as the return to consistent profitability
Valuation metrics however, tell a story of rising expectations. After trading on just 10.4 times earnings in 2023 — reflecting some accounting anomalies — Rolls-Royce now carries a forecast price-to-earnings (P/E) of 41.5 in 2025. This is expected to ease back into the 30s through 2027.
Dividend payments resumed in 2024 with a modest 6p per share, rising gradually over the following years. This equates to a forward yield of less than 1%, so it isn’t yet an income play. Based on today’s share price, the yield only tops 1% in 2027.
While this valuation might look a little extreme, it’s all about content. Rolls-Royce is forecasted to deliver strong earnings growth and it operates in sectors with incredibly high barriers to entry.
Looking around the sector, there are very few companies to compare it too. US-listed GE Aerospace trades with similar valuation metrics. Equally, UK-listed Melrose Industries, which has some of the same exposures, trades at just 16 times forward earnings despite having an impressive earnings forecast.
The bottom line
The recent share price strength has been fuelled by a string of positive announcements, including more strong earnings in H1 and raising its full-year guidance. The company should also benefit from a £10bn deal, announced in August, which will see the UK supply Norway with Type 26 frigates.
Despite what seems to be an endless array of catalysts, investors should be aware of the risks. The business could struggle if airline traffic weakens or if defence budgets come under political pressure. Equally, with valuation multiples already stretched, any earnings disappointment could trigger a sharp pullback.
Personally, I still believe the stock’s worth considering, noting long-term supportive trends in aviation, defence, and even nuclear power. However, my personal sector preference is Melrose and I think it deserves further research.
