The investment returns from unloved stocks are potentially considerably higher than from hot stocks everyone’s buying. Of course, for the potential to become reality, an unloved stock must be capable of delivering an improving performance.
Aerospace giant Rolls-Royce (LSE: RR), whose shares are down 16% so far this year, and precious metals miner Fresnillo (LSE: FRES), down 32%, are two FTSE 100 stocks I believe have strong credentials for recovery. Here’s why I’m optimistic their shares will fly in 2020.
Progress overshadowed
The Rolls-Royce share price hit a decade low of little more than 500p five years ago, but by last year had recovered to over 1,000p. However, it proved to be a false dawn, with the shares currently trading below 700p.
The doubling of the share price between 2015 and 2018 came as investors grew increasingly confident about the restructuring of the business and its future prospects. Unfortunately, continuing underlying progress has been overshadowed by well-publicised issues with the company’s Trent 1000 engines.
Upside of 100%+
Putting the Trent 1000 issues right is proving time-consuming and expensive. Management told us in November it now expects total in-service cash costs of around £2.4bn across 2017-23. However, with the company having designed eight of the nine fixes required, I think there’s every chance its latest reset of its financial and operational expectations for Trent 1000 will be the last.
If this is the case, I’m confident investor sentiment will improve through 2020 and lead to strong gains for buyers at today’s share price. This is because management has guided on free cash flow (FCF) of “at least £1bn” (about 52p a share) for the coming year. It has also said that after 2021, “as the Trent 1000 costs subside, we remain confident in our mid-term ambition of at least £1 of FCF per share.”
I think a healthy Rolls-Royce would merit a price/FCF ratio in the mid-teens. Hence, I can see the current 696p share price more than doubling in due course, which is why I rate the stock a ‘buy’ at this level.
Compelling value
The 32% fall in Fresnillo’s share price this year to sub-600p, is part of a longer-term slump from a peak of near 2,000p in 2016. In the last couple of years, the company’s start-of-year production guidance has repeatedly been downgraded as the year has progressed.
Its Q3 report in October was another disappointment, with production for 2019 “likely to be at the lower end of the guided ranges of 55-58 moz (including Silverstream) silver and 880-910 koz gold respectively.” These were narrowed to around 55 moz of silver and 885 koz of gold at a Capital Markets Day three weeks ago. At this event, management also gave us its guidance for 2020 of somewhat lower production of 54 moz of silver and 857 koz of gold.
I rate the stock a ‘buy’, because I think a rating of 23.7 times City forecast earnings (cheap by the company’s historical average) is compelling value. Furthermore, after the misses on production guidance in the last couple of years, I suspect management may have erred on the conservative side with its guidance for 2020. And with it “confident” it’s put measures in place that will deliver “operational improvement and efficiency,” I reckon we could be looking at a year in which the company under-promises and over-delivers.
