Is Rolls-Royce share price a 52% bargain ahead of earnings?

Rolls-Royce share price has retreated in the past few weeks as some investors start taking profits after a spectacular rally earlier this year. The stock dropped to a low of 445p on Tuesday, down by almost 9% from its highest point this year. 

Industrial earnings going on

Rolls-Royce stock price has wavered in the past few weeks as investors watch the ongoing earnings season. Last week, GE Aviation, its biggest competitor, published strong numbers as its total orders rose by 18% to $11.28 billion. Its revenue of $9.1 billion was higher than the consensus expectations. 

The other notable results came from Airbus, the biggest plane manufacturer in the world. It delivered 323 aircraft in the year’s first half, bringing in over 28.8 billion euros in revenues. These numbers, while good, demonstrated that the industry was going through significant challenges as the supply chain issues remain. 

Boeing, the embattled company, is expected to publish its earnings on Wednesday. Analysts have weak expectations as the company goes through a painful turnaround strategy after major missteps in the past few months. 

These results come at a time when many large industrial companies have done well. GE Aviation stock sits at a record high. The same is true with firms like Safran, Lockheed Martin, and Rolls-Royce.

Rolls-Royce earnings ahead

Thursday will be an important day for Rolls Royce, the second-biggest jet engine manufacturer in the world as it publishes its financial results. 

These will be important results for three main reasons. First, they will show whether the company is handling the supply chain challenges well. 

Second, the numbers will provide evidence on whether it is being affected by the recent trends in the civil aviation industry. Most airlines like Delta Air Lines, United, and Ryanair have reported weak results recently, citing the growing overcapacity and soft demand. 

Third, the results will show whether Rolls-Royce is working towards CEO Tufan Erginbilgiç’s lofty ambitions. In his strategy update, he said that his near-term target was to generate operating profits of between £2.5 billion and £2.8 billion. He also hopes to generate between 165 and 18% return on capital and between £2.8 billion and £3.1 billion in free cash flow.

Rolls-Royce is aiming to achieve these goals by reducing costs, increasing efficiency, and focusing on its core strengths. As a result, he is working to eliminate some of the lofty ambitions like the hydrogen engine project.

At the same time, he is looking into partnerships to re-enter the robust narrow-body jet engine that it abandoned a few years ago. Narrow-body aircrafts are doing better as more air lines have embraced a hub and spoke model.

Rolls-Royce valuation 

A key concern among investors is that Rolls-Royce Holdings has become a highly overvalued company after surging hard in the past few years. 

Valuation metrics about the company are a bit mixed. A discounted cash flow calculator by Simply Wall Street shows that the company is trading at a good value compared to its competitors. It estimates that it is trading at 52.4% below its fair value of 935p. 

Rolls-Royce DCF calculation

The company also has lower valuation multiples than its peers. It has a price-to-earnings ratio of 15.6, which is lower than the FTSE 100 index and other industrial companies. BAE Systems has a P/E multiple of 20.7 while Babcock International has 16 and GE Aviation trades at a 40x multiple. 

Safran has a multiple of over 30 while the FTSE 100 index has an average P/E multiple of 18. In the United States, the S&P 500 has a valuation multiple of over 20.

These numbers mean that Rolls-Royce has more upside to go to bridge the gap with its peer companies. This trend will only happen if the company manages to work towards its target metrics and if its product quality remains steady. In the past, faulty Trent 1000 engines cost it substantial sums of money.

Rolls-Royce share price forecast

RR chart by TradingView

The RR stock price has done well in the past few years as it moved from below 100p in 2020 to over 440p today. 

On the daily chart, we see that the Rolls-Royce share price has been in a strong bull run in the past few months. While the stock has retreated, it remains above the 100-day Exponential Moving Average (EMA).

Most importantly, Rolls-Royce seems to be forming a bullish flag chart pattern shown in blue. This pattern is characterized by a long flag pole and a rectangle pattern. In most cases, it usually results in a strong bullish breakout.

Therefore, there is a likelihood that the Rolls-Royce share price will rise after its earnings on Thursday. If this happens, it will likely rise and retest the important resistance point at 490p, its highest point this year. 

The post Is Rolls-Royce share price a 52% bargain ahead of earnings? appeared first on Invezz