Rolls-Royce (LSE: RR) is a great British brand and the company has gone from strength to strength over the past few decades. However, the recent investigation by the Serious Fraud Office into allegations of bribery and corruption at Rolls-Royce, has put a black mark next to the company’s shares.
Along with allegations, Rolls-Royce is also struggling with the strong pound and falling defence spending around the world. Nevertheless, these weaknesses are mostly short-term, and over the long-term, Rolls-Royce is set to profit as demand for the company’s services should only rise.
One of Rolls-Royce’s most attractive qualities is its long order backlog, which stood at £70.4bn at the end of the first half of the year. To put this into some perspective, Rolls-Royce reported revenues of £15.5bn for full-year 2013, so the company’s order backlog locks in four-and-a-half years of revenue.
Unfortunately, the company lost jet engine orders worth £2.6bn, after Emirates airline cancelled a planned purchase of 70 A350 aircraft from Airbus earlier this year. Still, management said that the cancellation would only shave 3.5% from its order book, but believes that other airlines would fill the delivery slots. There was a further cancellation relating to Skymark Airlines of Japan, which reduced Rolls-Royce’s order book by 0.5%.
And there’s no reason to suggest that Rolls-Royce’s order book won’t grow over time., especially for jet engines.
According to aviation industry leader Boeing, over the next two decades the world will need 35,280 new aircraft, worth a total of over $4trn. That’s a colossal figure and one that should excite Rolls-Royce’s investors.
Indeed, with solutions designed to power more than 30 types of commercial aircraft, and an existing fleet of almost 13,000 engines in service around the world, Rolls-Royce is well positioned to grab a share of this market.
With a leading position in a market worth more than $4trn over the next 20 years, and an order backlog locking in more than four years worth of revenue, it would understandable if Rolls-Royce traded at a sky-high valuation.
However, considering the above factors and the strength of the Rolls-Royce brand, the company currently looks cheap — its shares currently trade at a forward P/E of 15.9, falling to 14.6 for 2015. And the company currently supports a dividend yield of 2.1%, forecast to hit 2.3% next year.
For some, Rolls-Royce’s valuation may seem expensive, after all, the FTSE 100 only trades at an average P/E of 13.9. Still, in the words of Warren Buffett, it’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price and Rolls-Royce is a wonderful company trading at a fair price.
Not just Rolls
Rolls’ position within the world’s aviation market makes it a solid long-term investment. However, finding companies with similar defensive qualities to those of Rolls-Royce can be tough.
Rupert Hargreaves has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.