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Why I believe the Rolls-Royce share price is too cheap to ignore

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Rolls-Royce Holding (LSE: RR) confirmed on Thursday that it is to cut 4,600 managerial and support jobs, and most of the losses are going to happen here in the UK where the company employs 23,000 of its total workforce of 50,000.

But while that’s obviously bad news on the jobs front, it’s an inevitable part of the restructuring needed to get back to sustainable profits growth.

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The aerospace giant has been hit this year by maintenance problems with its Trent 1000 engines, after having had to replace some parts afflicted by corrosion and cracks. That’s had an impact on its financial targets and on the Rolls-Royce share price — while the price is largely flat so far in 2018 overall, it’s been very erratic as investors respond to short-term events.

But at 861p at the time of writing, are the shares too cheap to ignore right now? I thought so at 846p in January, and I still think so today.

Cost savings

Around a third of the job losses should happen this year, with the total reductions completed by mid-2020. Along with the rest of the company’s restructuring, net cost savings of £400m per year are expected by the end of 2020.

Chief executive Warren East said: “These changes will help us deliver over the mid and longer-term a level of free cash flow well beyond our near-term ambition of around £1bn by around 2020.

A forward P/E of 25 based on 2019 forecasts is probably putting off a lot of investors. But looking beyond that, if Mr East’s prediction comes off, I think we’ll see how cheap Rolls-Royce shares are at current price levels.

And who knows, we might even see the dividend start to pick up again.

Satellite controversy

The UK’s aerospace industry certainly isn’t without problems right now, and the latest Brexit spat which could see Britain taking no further part in the EU’s Galileo satellite navigation system is not good news. UK engineers, until now, have assembled the payloads for each satellite launch, and any share of the next €400m phase of launches looks almost certainly lost.

Does this mean we should avoid aerospace engineers like BAE Systems (LSE: BA)? Not a bit of it. I liked BAE when I took a look at its full-year results in February, and since then the share price has gained 15% — compared to 6.5% for the FTSE 100.

Slow growth?

One thing that does concern me is a lack of strong forecasts from the City’s analysts. We’re currently looking at a flat period this year, with reasonable EPS growth of 8% on the cards for 2019. The dividend is creeping up slowly too, and is set to yield 3.5% this year — not exactly a cash cow, but still decent.

But while defence spending has started ramping up again after a few cool years, I’m disappointed that a bigger share of it does not appear to be heading BAE’s way.

On the plus side, today’s BAE is looking like a leaner operation than it has been, with net debt almost slashed in half in 2017 — from £1,542m a year previously, to just £752m in December. And the pension deficit was sliced from £6.1bn to £3.9bn.

With a 2019 P/E of around 14, I think we’re still looking at good value shares.

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Alan Oscroft 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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