A week or so ago, Rolls-Royce (LSE: RR) shares were above 90p and creeping steadily towards the £1 mark. But a tough new week on the stock market, darkened by economic storm clouds, has sent them back down again.
At 88p at the time of writing, there’s still time to buy for less than a pound. But for how much longer? And is Rolls-Royce a good buy at such a low price anyway?
The Fed’s bigger-than-expected interest rate rise spooked US markets in the week. It was closely followed by a hike from the Bank of England to 1.25%. And forecasts suggest UK inflation could top 11% before the year is out.
Who’d buy Rolls-Royce shares?
Couple all that with aviation chaos, and fears that a recession will put a dent in holidaymakers’ travel money, and who’d invest in airline stocks or in companies dependent on the sector?
The main cause of the weakness is still the pandemic crunch. When airlines aren’t flying, they don’t put the miles on their Rolls-Royce engines. That means Rolls doesn’t get the mileage-related payments under their maintenance contracts. And that’s where the company really gets its income, not so much from direct engine sales.
But we are seeing flyers getting back on plane seats this year. It has been a bit chaotic. But it’s surely the start of the road back to normality.
This is all very well. But for investors to get back on board, they need to believe that Rolls-Royce shares are good value now. In 2021, the company managed to creep into profit territory, but only just. So the usual earnings-related measures don’t mean a lot.
Valuation measures
Revenue came in at £11.2bn for the year. With Rolls having so much debt, I like to check things on an enterprise value (EV) basis. That takes debt into consideration. And without it, the figures can look misleadingly good.
On an EV basis, I calculate a price-to-sales ratio of approximately 1.1. The airline’s revenues for the whole of 2021 came in slightly ahead of its total market cap plus net debt.
That looks good to me, but I want to refine it further. Reported net debt includes lease liabilities, and that’s really not the same as borrowing. Excluding leases, the PSR drops below one, which is even better.
Much of what happens now will depend on how the next couple of quarters go, and on the company’s priorities. Rolls says that the proceeds from ongoing disposals, plus any underlying free cash flow, will be used to pay down debt.
Enough cash now?
If that goes according to plan, I reckon remaining fears over liquidity should start to lift. I was concerned that Rolls might need to raise more cash. But I now doubt that’s going to happen and I’m happy with the liquidity situation now.
So what do I think will happen with the Rolls-Royce share price? Those clouds are still on the horizon. And lofty ambitions can easily become unstuck. But yes, I do think there’s a strong likelihood of Rolls shares breaking through 100p in the not-too-distant future, and staying there.
