Is Rolls-Royce Holdings (LSE: RR) a no-brainer buy, or something to avoid? I’m looking at few things I think could make Rolls-Royce shares a buy for 2023. And a few that might suggest otherwise.
The shares are down around 30% in 12 months, and they’ve lost two thirds of their value over five years. But they’ve regained some lost ground in the past couple of months.
So sentiment seems to be improving towards the aero engine maker. And that can often be a good indicator of a shift in fortunes for shareholders. However, we saw a false start in 2021, and those gains soon fell back.
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But the airlines industry is finally building strength again, and that lies behind Rolls-Royce’s fortunes. International Consolidated Airlines, the owner of British Airways, reported an upbeat third quarter. CEO Luis Gallego told us: “Leisure demand is particularly healthy and leisure revenue has recovered to pre-pandemic levels.”
Profit?
Rolls gets its profits mainly from maintenance contracts, based on the hours flown on its engines. It clearly needs the planes to be in the air, which they increasingly are. In its own November update, Rolls spoke of “large engine flying hours at 65% of 2019 levels in the four months to the end of October and up 36% year to date“.
But at the halfway stage, the company reported a £1.6m loss, still with free cash outflow. There was an underlying operating profit, but it was lower than the first half of 2021. Still, these negative figures are small, and I expect to see the return of sustainable profits before too long. Analysts predict a small profit for the full year.
Debt
But it could be a while yet before Rolls can rake in enough profits to get its debt paid down to healthy levels. At 30 June, net debt stood at £5.14bn, only slightly lower than the December 2021 level.
Since then though, the sale of ITP Aero enabled Rolls to repay £2bn of debt, so the pile is coming down. But there’s a limit to how much can be sold off to pay debt. And it leaves shareholders with a stake in a reduced business.
Valuation
For the past few years, it’s been near-impossible to put any kind of fundamental valuation on Rolls-Royce shares. And when the firm is still around the pivot point between loss and profit, it remains tricky. But it looks like that’s easing, at least going by forecasts.
We’re looking at a P/E for this year of around 75. But forecasts have it coming down below 14 by 2024. And analysts are already expecting a small dividend by then. Relying on forecasts is very risky though, so I’d rate the Rolls valuation as still rather uncertain.
Verdict?
With that high debt and a still-uncertain outlook, I couldn’t rate Rolls-Royce shares as a no-brainer buy now. I’m seeing increasing attraction in the stock however. But it needs a clear head and careful thought.
My eyes are peeled for full-year results, due on 23 February.
