Defence contracts could make the Rolls-Royce share price explode! Is it a buy?

The Rolls-Royce share price could be seriously undervalued, but will its new defence contracts with the U.S put it back on track to new all-time highs?

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Despite some excellent fundamentals, the Rolls-Royce (LSE: RR) share price has lost a lot of value over the past five years. But with the announcement of a new US$2.6 billion contract with the U.S Air Force, I think we are on track to see a return to those highs and possibly push past them.

After debuting in 1987 as part of a wave of privatisation, Rolls-Royce’s share price traded sideways until the end of 2010, when the company secured a £750 million pound deal to supply and service jet engines on behalf of China Eastern Airlines.

Since then, Rolls-Royce shares have been in a steady decline, losing nearly 75% of their value between 2018 and 2020. This can appear very scary to many new investors, but I think that this dip actually presents an excellent opportunity to get in while the company is undervalued.

Fundamentals

Price action isn’t everything when it comes to a share’s value. Rolls-Royce may have a few more outstanding shares than would be ideal (with a total number of 8.1 billion), but its price-to-earnings ratio is an astounding 3.62!

The company does also pay a dividend, but the value of that dividend moves up and down depending on how well the company is doing, which suggests good management that is focused on the long-term health of a company instead of the immediate wishes of shareholders.

The defence contracts

The contract making all the headlines today is the one Rolls-Royce has signed with the U.S.A.F to refit its fleet of B-52 bombers with new F130 engines. If all that is gibberish to you, all you need to know is that Rolls-Royce will be manufacturing these engines along with all of their spare parts from its factory in Indiana and is expected to be tasked with the maintenance of these planes all the way up until 2050.

On top of that, Rolls-Royce has also secured contracts to refit the U.K’s own aircraft carrier with a new engine and to design a propulsion system for the military jet developer AERALIS.

All of this makes me very confident that the Rolls-Royce share price is due for a return to its all-time high, with a real possibility of pushing past that number, and so I’m adding the shares to my watch list.

Problems ahead

With any investment, there are risks I must consider. There is a chance that Rolls-Royce may not be able to meet its contractual obligations or a change in the U.S administration may lead to an adjustment in priorities. However, I view this as unlikely since the recent AUKUS alliance shows a shifting of focus within the anglophone world, away from the Middle East and towards an ascendant China. We haven’t seen a Cold War type arms race since 1989 and many industries can expect to benefit from the U.S.’s desire to outmatch its rivals.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

James Reynolds 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.

More on Investing Articles

Middle-aged white man wearing glasses, staring into space over the top of his laptop in a coffee shop
Investing Articles

2 shares I changed my mind about in today’s stock market

This writer explains why he changed his opinion on these two shares, even though both are highly valued in today's…

Read more »

Investing Articles

6 stocks that Fools have been buying!

Our Foolish freelancers are putting their money where their mouths are and buying these stocks in recent weeks.

Read more »

Google office headquarters
Investing Articles

1 reason I like buying S&P 500 shares – and 1 reason I don’t

Will this investor try to improve his potential returns by focusing more on S&P 500 shares instead of British ones?…

Read more »

Young woman holding up three fingers
Investing Articles

3 SIPP mistakes to avoid

Our writer explains a trio of potentially costly errors he tries to avoid making when investing his SIPP, on an…

Read more »

Smiling white woman holding iPhone with Airpods in ear
Investing Articles

Here’s how (and why) I’d start buying shares with £25 a week

Our writer uses his investment experience and current approach to explain how he would start buying shares on a limited…

Read more »

Aerial shot showing an aircraft shadow flying over an idyllic beach
Investing Articles

Here’s my 5-step approach to earning passive income of £500 a month

Christopher Ruane explains the handful of steps he uses to target hundreds of pounds in passive income each month.

Read more »

Investing Articles

2 UK shares I’ve been buying this week

From a value perspective, UK shares look attractive. But two in particular have been attracting Stephen Wright’s attention over the…

Read more »

Investing Articles

A lifelong second income for just £10 a week? Here’s how!

With a simple, structured approach to buying blue-chip dividend shares at attractive prices, our writer's building a second income for…

Read more »