Rolls-Royce Holdings (LSE: RR) has announced a $5bn contract to supply engines for 50 new Delta Air Lines aircraft. The firm said that the deal added $3bn to its order book, and comes in the wake of a number of other recent wins.
I’ve previously been pretty cautious on Rolls-Royce, and have set a 750p target buy price for the stock, but in the wake of today’s big win, I reckon it’s time to take a fresh look at the firm: could a turnaround come sooner than expected?
Aero profits are key
To put today’s Delta Air Lines contract win in perspective, Rolls-Royce’s order book was worth around $110bn at the end of June. Adding $3bn to that is useful, but it’s not going to drive a fundamental re-rating.
However, does the quality and profitability of Rolls’ aero engine business make it worthy of a higher valuation?
Rolls’ civil aerospace business accounts for 44% of its sales and is the firm’s second most profitable division, according to its latest accounts. The firm’s engine sales are supplemented with lucrative service contracts, giving an underlying operating margin of around 14%, second only to Rolls’ defence aerospace division, where the equivalent figure is 17%.
On this basis, news of continued growth in civil aerospace is encouraging, especially as profits and revenues from Rolls’ defence aerospace business are expected to fall by between 15% and 20% this year.
Is Rolls cheap enough to buy?
After its latest profit warning in October, it was reassuring to see Rolls maintain its guidance for 2014/15 in the firm’s November trading update.
However, the firm’s shares have bounced back more than 8% from their October low, and currently trade on a forecast P/E of around 13.5, with a prospective yield of around 2.7%. That doesn’t seem obviously cheap, to me, given that the firm’s profits are expected to edge lower next year, leaving dividend growth uncertain.
Rolls is undoubtedly a good business, but I’m not completely sure that we’ve seen the last of its recent problems.
For one thing, the firm’s new finance director, David Smith, hasn’t yet had time to conduct his own audit of the firm’s accounts, after his predecessor, 27-year Rolls veteran Mark Morris, departed suddenly and without explanation at the start of November.
I’m going to wait until Rolls publishes its result in February before deciding what to do — I’m happy to risk missing out on the start of any recovery, as I feel there are better buys in today’s market.
Roland Head 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.