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Why Rolls-Royce Holdings PLC Should Be A Winner This Year

Rolls-Royce

Engineering companies have started to shine over the past year or so as the recession has been fading, and today I’m taking a look at Rolls-Royce (LSE: RR) (NASDAQOTH: RYCEY.US), famous mainly for its aerospace engines which are heavily used by the likes of Airbus and in combat aircraft. Is it likely to be a winner in 2014?

Here’s a quick look at the past five years’ earnings and dividend figures, with forecasts for 2013 and the following two years:

Dec EPS Change P/E Dividend Change Yield Cover
2008 36.70p +8% 9.1 14.3p —  4.3% 2.6x
2019 39.67p +8% 12.2 15.0p +4.9% 3.1% 2.6x
2010 38.73p -2% 16.1 16.0p +6.7% 2.6% 2.4x
2011 48.54p +25% 15.4 17.5p +9.4% 2.3% 2.8x
2012 59.27p +22% 14.7 19.5p +11% 2.2% 3.0x
2013* 67.07p +13% 18.5 21.5p +10% 1.7% 3.1x
2014* 72.72p +8% 17.1 23.8p +11% 1.9% 3.1x
2015* 78.78p +8% 15.8 26.1p +9.7% 2.1% 3.0x

* forecast

Nice growth last year

Those are good earnings and dividend rises, but it’s clear that Rolls-Royce isn’t really much of a dividend investment at the moment — yields of around 2% are a good way short of the forecast FTSE average of 3.1%.

What we’re looking at here is really a growth opportunity, which is relatively rare for a FTSE 100 share. We’ve seen some decent growth already — and at around 1,250p, the share price is up nearly 40% over the past 12 months against a FTSE that has struggled to top 10%.

So after such a year, is there anything left? I think there is.

Forecasts

For a start, we have slowing but impressive earnings growth forecast for the year just finished and for the next two years, after a couple of years of rapid recovery. And with economies strengthening I feel those expectations could be a little on the conservative side — at third-quarter update time, Rolls-Royce had made some significant progress in snagging new contracts, and it’s added impressively to that since.

Looking back to July’s first-half results, Rolls-Royce told us that expected modest growth in both civil and defence aerospace. But a closer look reveals a pretty strong first half for the company’s oft-overlooked Marine division, which recorded an impressive 16% rise in revenue and a 10% boost to its order book — its Marine business accounts for around 18% of Rolls-Royce’s turnover.

Valuation

Sure, December 2013 expectations put the shares on a price-to-earnings (P/E) ratio of 18.5, which is certainly ahead of the FTSE’s long-term average of 14 — but forecasts for the next 12 months actually put the FTSE on a P/E of 17, so it looks like there’s growth expected across the board.

Rolls-Royce, then, isn’t really that highly valued relative to the overall market, even if it is priced more richly than some of its engineering peers — BAE Systems, for example, commands a P/E of only around 11.

But with further forecasts dropping the Rolls-Royce P/E to 17 for 2014 and then under 16 the following year, I really can see a positive year for Rolls-Royce shareholders this year.

Verdict: Strength in defence for 2014.

Finally, while Rolls-Royce might not be a key choice for dividend-seekers, there are plenty of top FTSE 100 companies that are paying out a lot more cash. If you want to learn how to identify them for yourself, have a look at the new Motley Fool report "How To Create Dividends For Life", which gives you 5 Golden Rules for Building a Dividend Portfolio.

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> Alan doesn't own any shares in Rolls-Royce or BAE Systems.