Right now, shares in Rolls-Royce (LSE:RR) are hovering around the £1.50 mark. At the beginning of January, they were 98p.
That’s obviously a significant rise since the start of the year. But with a new CEO on board, determined to push the company towards new highs, could the stock still be a bargain?
A turnaround
Over the last few months, Rolls-Royce has been starting to emerge on the other side of a difficult period. And just lately, the stock has had a couple of tailwinds behind it.
The most significant of these is the return of air travel, especially long-haul flights. This is important because a lot of the company’s revenue comes from servicing the engines it provides for aircraft.
More usage means more frequent servicing needs. And this, in turn, means more high-margin revenue for Rolls-Royce.
Another reason is the company has a new chief executive officer. And since his arrival, Tufan Erginbilgic has been outspoken about his desire to transform the company.
The new CEO aims to boost profitability by improving efficiency. Rolls-Royce cut around 20% of its staff to stay afloat during the pandemic, but it looks like there’s more to come.
All of this means the next five years for the business are likely to be better than the last five. But with the stock up 50% since the start of the year, is the recovery already priced in?
A £12.6bn business?
Rolls-Royce currently has around 8.35bn shares outstanding. So a share price of £1.50 implies a market cap of around £12.6bn for the entire company.
Is that a lot? It depends on what else is on offer in the stock market – if Rolls-Royce looks likely to make more money relative to its price than other companies, then the stock might be a bargain.
Within the FTSE 100, there are some interesting stocks for comparison. Rolls-Royce’s current share price makes it around the same size as Bunzl (£10.6bn).
Unlike Rolls-Royce, Bunzl is not in the middle of a turnaround. It has been growing slowly and steadily, which makes it arguably more stable, but without the same scope for improvements.
For the current year, Rolls-Royce is forecasting around £800m in operating profit. Last year, Bunzl managed £757m and is forecasting for this to increase this year.
Bunzl, though, has a much better balance sheet than Rolls-Royce does. With less debt and less interest to pay, Bunzl is arguably in a better position to convert its income to free cash.
A stock to buy?
In summary, Rolls-Royce shares look to me to be reasonably valued at the moment. At least, they do when compared with another FTSE 100 stock trading at around the same price.
I can see a case either way for the stock at the moment. If the new CEO’s efficiency plans bear fruit, then earnings could grow and the stock could turn out to be a bargain.
Equally, I think there’s a good case to be made for thinking that the risks are too great right now. If I were looking to buy shares in a business with a £12bn price tag, I’d look to Bunzl instead.
