I can now buy a little slice of Rolls-Royce (LSE: RR) for a third less than I could when the year began — that is because the share price has tumbled 33% so far in 2022. Over the past year, the engineer’s shares have fallen by 23%.
So, is this lower price a potential bargain for my portfolio?
Share price down, profits up
Although the stock has been moving down in the past few months, the business has been going in the other direction. Indeed, in its most recent trading statement in May, the firm said that it “continue(s) to expect positive momentum in our financial performance in 2022 despite the ongoing risks around macroeconomic uncertainties.“
Last year, revenue slipped slightly but the company moved to a £124m profit from a £3.1bn loss the year before. That profit is small but I still see it as a sign of improving business performance. The company also returned to positive free cash flow, reducing the risk it needs to boost liquidity by diluting shareholders like it did a couple of years ago. I also do not mind the revenue falling slightly. The company has been reshaping its business and selling assets. A leaner but more profitable business would be a positive development for Rolls-Royce shareholders in my view.
Is the Rolls-Royce share price a bargain?
Given the improving business momentum, why have the company’s shares been getting cheaper?
One concern is ongoing disruption in civil aviation. Along with mounting economic concerns globally, that could lead to fewer flying hours for civil aircraft. That could hurt revenues and profits at Rolls-Royce.
But I think some investors have also been worrying about the business fundamentals. Its profit last year translated to earnings per share of 1.5p. So even at its current reduced share price, Rolls-Royce continues to trade on a price-to-earnings (P/E) ratio close to 60. That looks very expensive and certainly not a bargain.
If earnings improve in coming years, the forward-looking P/E ratio would seem more attractive. But for this year, the firm has guided that it expects “operating profit margin to be broadly unchanged” and to generate “modestly positive free cash flow”. That sounds like slow progress in the effort to get back to the sorts of earnings seen at the company in its heyday.
Why I’d buy
But even if the share price is not a bargain, I still think it can offer me good value as a long-term investor.
The business has stripped out costs. If customer demand recovers fully in coming years, that should mean profit margins improve, helping boost earnings. I expect much higher profits than we saw last year, even if it takes several years to achieve them. On that basis, I think the current valuation looks attractive. That is why I would consider acting on the Rolls-Royce share price and boosting my position in the company.
