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Why Rolls-Royce Holding plc is a dirt-cheap growth king

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The last few years have been somewhat challenging for Rolls-Royce (LSE: RR). The aerospace and defence company reported a pre-tax loss of £4.6bn last year and in the prior two years its profit was around 90% down on its 2012 level. This period of underperformance was partly caused by difficulties in the defence sector, where cost-cutting by governments around the world contributed to a significant slowdown.

Now though, the sector seems to offer an improved outlook. Alongside this, Rolls-Royce is making positive changes to its business model. As such, it could be a stunning investment opportunity for the long term.

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Improving outlook

Defence budget cuts across the developed world have been a feature of the last decade, and this has contributed to falling sales and profitability across the sector. As mentioned, Rolls-Royce has not been immune to this problem, and it has contributed to a sustained fall in the financial performance of the business.

Looking ahead, defence spending looks set to rise as the era of austerity now looks to be coming to an end.  This is at least partly because of the improving economic outlook for the developing world after a period of loose monetary policy. A focus on debt reduction does not seem to be high on the political agenda, with growth and higher spending having taken the place of careful fiscal management.

In addition, the election of Donald Trump as US president could push demand for defence products higher. He intends to raise spending on defence, while also suggesting NATO allies should do likewise. This could be good news for Rolls-Royce and its peers.

With the company forecast to post a rise in its bottom line of 18% in the current year, this puts its shares on a price-to-earnings growth (PEG) ratio of just 1.5, which indicates that they offer high growth at a very reasonable price. Certainly, their gain of 24% in the last year may lead some investors to question their upside potential. However, with an improving industry outlook and low valuation, Rolls-Royce could be a top performer in the long run.

Growth prospects

Also offering a mix of high growth and a low valuation is financial technology company NEX Group (LSE: NXG). It reported that its transformation programme made strong progress in the first half of the year. In addition, its NEX Optimisation division will increase investment in areas such as sales and marketing to create a more client-centric structure. This has caused the company’s share price to decline by around 7% following the news, since it means the division’s operating margin will be lower than expected, at just 20%.

Despite this, the stock seems to have upside potential. It is due to record a rise in its bottom line of 32% in the current year, followed by 18% next year. This puts it on a PEG ratio of just 1, which suggests that it could offer a strong recovery over the medium term.

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Peter Stephens has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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