Rolls-Royce (LSE:RR) still looks dirt cheap on paper despite its astonishing share price rise. At 211p per share, the FTSE 100 engineer has soared an astonishing 190% over the past 12 months.
Yet today, Rolls trades on a forward-looking price-to-earnings growth (PEG) ratio of 0.1. Any reading below 1 indicates that a stock is undervalued.
The company’s rock-bottom PEG reading reflects City forecasts that earnings will rise 369% in 2023. And what’s more, predictions of further growth (of 21% in both 2024 and 2025) mean the ratio sits below that sub-1 benchmark beyond this year too.
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These bright profits forecasts also make Rolls-Royce shares look attractive for another reason. They mean that analysts also believe dividends are about to be relaunched at the company.
Great growth
The FTSE firm hasn’t paid a dividend since Covid-19 grounded the world’s airline fleet and profits from its engine servicing division collapsed. But forecasters think shareholder payouts could return in 2024.
A full-year payout of 2.04p per share is currently anticipated. This creates a modest 1% dividend yield, below the UK blue-chip average of 3.8%.
Clearly, those hoping for a large near-term dividend income may want to shop elsewhere. However, for those seeking explosive payout growth, investors may want to give Rolls shares a close look.
For 2025, a total payment of 3.53p per share is predicted. This bumps the yield up to 1.7%. The engineer could continue growing dividends strongly beyond this period as well.
Good omens
One reason is the sustained improvement in the civil aerospace industry. Even as the cost-of-living crisis endures and interest rate rises curb economic growth, travel activity continues to bounce back strongly.
This week, United Airlines — one of the US’s ‘Big Three’ operators — announced forecast-beating quarterly results, noting it enjoyed “strength in close-in bookings in August and September with both months well ahead of year-over-year demand“.
Rolls’ dividends are also tipped to fly as its balance sheet has rapidly improved. Rising revenues, asset sales, and aggressive streamlining all helped net debt plummet to £2.8bn as of June.
The company remains committed to slashing costs too, and in recent days announced that up to 2,500 jobs could be cut from its global workforce of 42,000.
Chief executive Tufan Erginbilgic said the measures will create “a more streamlined and efficient organisation that will deliver for our customers, partners and shareholders.”
Big dangers
Yet despite these factors, I’m not tempted to buy Rolls-Royce shares for passive income. The global airline industry could still experience significant turbulence as the global economy splutters and oil prices rise. It’s a scenario that might see its balance sheet reparation strategy come to a halt.
The murky outlook is especially worrying given that Rolls must pay back a significant proportion of its debts by 2025. This was estimated at £1.3bn as of the turn of the year.
There are other significant dangers to current forecasts, including ongoing supply chain problems and the ever-present threat of project delivery problems.
The engineer also has to spend huge amounts of capital on its growth programmes, another potential drag on dividend growth.
I don’t think buying Rolls-Royce shares is worth the gamble right now. I’d rather buy other UK shares for long-term dividend income.
