Today I am explaining why Rolls-Royce (LSE: RR) (NASDAQOTH: RYCEY.US) could be set for lift off.
Warning sends share prices diving
Engineering giant Rolls-Royce has been one of the biggest stock market casualties of the past week. Shares in the business rattled 12% lower during Friday trading after the company issued its second profit warning of the year, noting that
“in the last few months economic conditions have deteriorated and Russian trade sanctions have tightened, leading a number of customers to delay or cancel orders.”
These issues have mainly affected the firm’s Nuclear & Energy and Power Systems divisions, and while underlying profit at constant exchange rates is expected to remain flat this year, Rolls-Royce advised that anything from further stagnation through to a 3% fall can be expected in 2015.
This warning, combined with a broader environment of risk aversion, has kept bargain hunters at bay for the time being. But I believe investors may be missing a trick, as Rolls-Royce’s long-term investment case remains a compelling one.
Plane sailing for long-term profits
More specifically, I am convinced that Rolls-Royce’s position as a top-tier component supplier to the world’s largest planebuilders such as Boeing and Airbus should allow it to enjoy solid revenues expansion as demand from the civil aerospace sector takes off.
Last week the Derby-based firm confirmed that it expects
“the market [to] strengthen, driven by increasing demand for travel in the emerging economies and the need to replace older aircraft with new fuel efficient models.”
Rolls-Royce’s Trent engines continue to set the industry standard, and constant innovation here has helped the company to secure a 50% market share in the large civil engine sector. This phenomenon has forced the company to bulk up capacity to meet surging customer orders, including the construction of a state-of-the-art engine factory in the emerging market hotspot of Singapore.
In addition, Rolls-Royce’s TotalCare aftermarket service is also a significant revenue driver for the division, and galloping demand here has also prompted the firm to build maintenance bases in locations such as Heathrow.
A bargain at current levels
Last week’s rampant sell-off has seen Rolls-Royce’s P/E multiple fall to just 12.5 times prospective earnings for 2014, based on Investec forecasts, rising to only 13.3 times for next year. Any figure below 15 is widely regarded as decent bang for one’s buck. In my opinion this creates formidable value for money given the company’s tremendous growth prospects.
It is true that the civil aerospace sector accounts for a chunky 43% of total underlying profit at present, and that weakness across Rolls-Royce’s other divisions bodes ill for group profits in the near-term.
Still, I believe that the firm’s top-tier status in the planebuilding market — not to mention strong progress of its cost-cutting programme — should blast profits higher again in coming years, particularly once current cyclical headwinds in the global economy abate and performance across the group picks up.
Royston Wild 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.