The Rolls-Royce (LSE:RR.) share price has made a lightning-fast start to 2023. The FTSE 100 enginebuilder is up 15% in value since January trading began. There’s a good chance of more terrific gains in the months, too.
Yet it’s caught my eye that its shares continue to offer excellent value despite those recent gains. City forecasters expect annual earnings to soar 477% in 2023, a prediction that leaves the company trading on a forward price-to-earnings growth (PEG) ratio of 0.1
Any reading below one indicates that a stock is trading below value.
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This doesn’t necessarily mean that Rolls-Royce shares offer excellent value though. Some shares carry low valuations owing to the high risk to profits. So is Rolls too cheap to miss? Or is it pitfall for investors to avoid?
China is reopening
Loosened Covid-19 restrictions in China have blasted Rolls-Royce’s shares higher over the past month. As markets analyst Susannah Streeter of Hargreaves Lansdown has commented: “There are high hopes that China’s reopening will help herald a renewed love for long haul travel”.
She notes that looser rules will provide the FTSE 100 business a boost given “its core business of manufacturing and maintaining commercial jet engines”. Asia has become the fastest-growing aviation market in the past decade as wealth in the region has rocketed.
A scientist with China’s Center for Disease Control and Prevention predicts that 80% of the country has now been infected with Covid-19. This suggests that cases have now peaked and that a return to lockdowns is unlikely. But I’m conscious that new variants of the virus could put the country back again and hamper air travel once more.
An uncertain recovery
I’m also aware that air traffic could sink if the global economy moves into recession. This would hit the money Rolls-Royce makes from engine servicing, while weakened airline profits might also reduce orders of its power units.
Spending on big-ticket items like holidays tends to fall sharply as economies shrink. Business travel also slips as companies try to save cash.
Having said that, the worsening cost-of-living crisis has failed to stymie a strong recovery in the civil aviation sector. In fact easyJet this week raised its full-year forecasts on account of record booking days in January.
Big debts
It’s true that the profits outlook for many UK shares is plagued with danger in 2023. But what perhaps makes Rolls-Royce shares riskier than many is the size of its huge debt pile.
It had £4bn worth of undrawn debt as of September. So it needs the profits to keep rolling in to help it pay down these immense liabilities. Persistently-high debts could weigh on its investment in growth programmes like low-emission engines. They might also hamper its ability to restart dividend payments.
The verdict
The Rolls-Royce share price looks cheap on paper. But I believe the company still carries too much risk right now. With high cost inflation and supply chain problems threatening to persist, too, I’d rather buy other value stocks to try and make long-term returns.
