Rolls-Royce (LSE: RR) saw its share price jump sharply this morning. As I write, the stock’s up 14% to over 1,000p. The last time it was this high was over three years ago, back in May 2015. Only a few days ago, the shares were changing hands for 830p. So what has caused the FTSE 100 company’s share price to spike all of a sudden?
Restructuring
The reason for today’s surge is that the group has provided further details of its restructuring, initially announced yesterday. It has also outlined its mid-term financial ambitions, and investors are clearly impressed with the news.
Rolls-Royce’s goal is to deliver improved returns, higher margins and increased cash flow. It wants to create an organisation that is both more simple and more dynamic. As a result, after a review of its structure and processes, it has decided to cut 4,600 jobs, with around a third of these to go the end of the year. While the restructuring will cost the company around £500m, it expects that the full-year net cost savings will reach £400m per year by the end of 2020.
Chief financial officer Stephen Daintith commented today: “We are coming out of a significant investment cycle and are poised to deliver much-improved returns. The restructuring programme is a key enabler to delivering reductions in our fixed costs while allowing our businesses to be more accountable for their own costs.”
Ambitions
Rolls-Royce has also stated that it’s committed to generating “significantly improved returns.” Its mid-term ambition is to exceed £1 per share of free cash flow generation. In 2017, it generated just 15p of free cash flow per share. It’s also targeting a cash flow return on invested capital ratio of 15% through the cycle. Last year, the ratio was 9%. So, it’s clear that Rolls is looking to boost cash flow considerably.
Furthermore, the group said today it has “ambitious targets” for further improvement and growth within its Power Systems division. Its medium-term ambition is to achieve revenue growth of 3-5% above underlying GDP and an operating profit margin in the mid-teens, against last year’s 11.3%.
Time to buy?
With sentiment towards Rolls-Royce improving, is now the time to buy the shares Personally, I’m not convinced it is.
Chief executive Warren East seems to be doing a good job of transforming the business since taking over in 2015. However, the valuation of the shares doesn’t leave much of a margin of safety, in my opinion.
Currently, analysts expect earnings of 18p and 30p per share for FY2018 and FY2019, respectively. At the current share price, those estimates equate to forward P/E ratios of 56 and 33, which suggest there’s not a lot of value on offer right now.
There’s also not much in the way of dividend appeal. Last year, the group paid out 11.7p per share in dividends, which equates to a trailing yield of just 1.2%. In contrast, the FTSE 100 has a median trailing yield of 2.7%.
Weighing up the valuation and yield, Rolls isn’t a ‘buy’ for me right now. I think there are better opportunities in the FTSE 100, including a few of the stocks listed in the free report below.
