Rolls-Royce (LSE: RR.) shares are a popular investment right now. Last week, for example, Rolls was the most bought stock on Hargreaves Lansdown.
Now Rolls-Royce isn’t a stock I’d personally buy (I’ll explain why later). However, I can see reasons why investors might want to buy the shares today.
Better-than-expected results
Let’s start with the fact that Rolls-Royce just posted results that were much better than expected. Helped by a recovery in air travel, the group posted an underlying operating profit of £652m for 2022 – well above analysts’ forecast of £478m.
Looking ahead, the company said it expects to generate a profit of between £0.8m and £1m this year along with free cash flow ranging £0.6m-£0.8m.
A continued recovery in our end markets and the actions we are taking give us confidence in delivering higher profit and cash flows in 2023.
Rolls-Royce management
On the back of these better-than-expected results, City analysts have been scrambling to upgrade their FY2023 earnings estimates. Over the last month, the consensus earnings per share forecast has risen from 3.4p to 4.5p. This kind of earnings upgrade activity is generally positive for a company’s share price.
Brokers have also been raising their share price targets. For example, analysts at Jefferies just raised their target price to 170p from 125p while analysts at Bernstein raised their target price to 165p from 108p. Price target upgrades can also boost a stock.
Room for growth
Another reason to consider buying is that there appears to be room for further growth beyond 2023.
In its full-year results, management noted that for 2023, it is assuming that large engine flying hours (Rolls-Royce’s revenues are linked to engine flying hours) will be 80-90% of 2019’s level. So there’s space for revenues to grow.
One factor that could give the company a boost here is China’s reopening. This should lead to a sharp increase in the number of flights into and out of China, propelling engine flying hours higher.
New management
A third reason to be bullish is that Rolls-Royce has a new CEO, Tufan Erginbilgic. And he appears to be determined to improve the company’s performance.
“While our performance improved in 2022, we are capable of much more,” he said in the company’s full-year results.
It’s worth noting that since Erginbilgic has come on board, he has launched a strategic review of the company. The aim is to create a stronger, growing business with a clear proposition for investors. This is a positive development.
Why I’m not buying
So why am I not interested in buying Rolls-Royce shares? Well, it all comes down to my style of investing. I like to invest in high-quality businesses that have:
- Long-term growth potential
- A track record of consistent growth and high profitability (return on capital)
- A solid balance sheet
I’ve found that this ‘quality’ approach tends to deliver good results over the long term.
Unfortunately, Rolls-Royce pulls up short in a few of these areas. For example, in the past (pre-Covid), its return on capital has often been negative. Meanwhile, its net debt is quite high relative to its profits.
So, ultimately, while there’s a lot to like about Rolls-Royce, there are other stocks that are a better fit for my portfolio right now.
