On 25 February, just before Rolls-Royce Holdings (LSE:RR.) announced its 2025 results, the aerospace and defence group’s shares were changing hands for £13.10 each. Today (6 April), its share price has fallen 9.1% to £11.91, roughly where it was at the start of the year.
But one person’s cast-off can be someone else’s find. On this basis, could this be a chance to buy into a FTSE 100 legend at a knockdown price? Let’s see.
Some numbers
Just before publishing its results, analysts were expecting Rolls-Royce to report an underlying operating profit of £3.27bn and free cash flow (FCF) of £3.19bn. Earnings per share (EPS) were forecast to be 29p. For 2028, they were predicting this to rise to 43.6p.
In terms of valuation, this meant the group was trading on 45.2 times forecast (2025) earnings, dropping to 30 when looking ahead to 2028. However, the group did better than expected. It reported EPS of 29.5p, 1.9% higher. And more importantly, it announced an upgrade in its forecasts.
For 2028, it said it was now targeting an underlying operating profit of £4.9bn-£5.2bn and FCF of £5.0bn-£5.3bn. Based on the mid-point of its earnings forecast, this would translate into EPS of around 45.2p. If realised, it means the forward (2028) price-to-earnings ratio would be 26.3.
That’s cheap for a rapidly-growing company. Could this be a brilliant entry point for new investors?
Trouble overhead?
Events of six years ago are a reminder of how vulnerable the group is to a downturn in the aviation industry. When the pandemic closed our skies, much of Rolls-Royce’s revenue dried up. And I don’t think it’s an exaggeration to say that it nearly went bust.
The current conflict in the Middle East has led to thousands of flights being cancelled. Inevitably, this will have led to some loss of revenue for Rolls-Royce although — at this stage — I suspect it’s not enough to materially change the group’s forecasts.
However, potentially of more significance, there could be a reduction in the future demand for air travel if, as a result of higher jet fuel costs, ticket prices rise and disposable incomes are squeezed due to an increase in general inflation.
Also, with an abundance of land and cheap energy, the Gulf’s become a hotbed for data centres. Rolls-Royce’s power systems division has been growing on the back of these electricity-thirsty facilities. But if economies in the region suffer long-term damage as a consequence of the war, investment in the sector may slow.
My view
However, I try to take a five-year (at least) view. And in doing so, the investment case looks compelling. I see huge potential from its small modular reactor programme. In addition, its defence business is likely to benefit from ongoing geopolitical uncertainty. The group’s also planning a return to the lucrative narrowbody aircraft engine market.
Okay, describing Rolls-Royce’s shares as an unmissable bargain may be a bit of an exaggeration. After all, there are plenty of other cheap stocks I have my eye on at the moment. But the recent pullback in the group’s share price — and the upgrade in its earnings forecasts — means its current valuation is much more attractive than it has been for quite a while.
I think it’s a stock that long-term investors could consider.
