A correction is defined as a drop of at least 10% in the price of a stock from its recent high. Given that the Rolls-Royce (LSE: RR) share price has fallen from 227p in September to its current 202p, we’re looking at an 11% correction in the stock.
Of course, this isn’t necessarily anything to worry about. In fact, corrections can simply provide timely opportunities to accumulate more shares at a lower cost basis.
I’m open to adding more Rolls-Royce shares to my ISA at the right price. Is this my chance?
Why have the shares tailed off?
The reason for the recent decline is probably an absence of news to spark a share price movement. Yes, there was a recent statement from Rolls-Royce announcing 2,500 job losses as part of its cost-cutting efforts. But the market was anticipating this under the new CEO’s transformation plan.
This is in contrast to the regular positive upgrades appearing at the start of the year, which culminated in an outstanding first half. Organic group revenue increased 28% year on year to £7bn, with strong growth across all three core divisions.
Free cash flow rocketed to £356m from an outflow of £68m in H1 2022. And the company raised its full-year profit forecast to £1.2bn-£1.4bn, up from its previous range of £800m-£1bn.
Topping this update was always going to be difficult.
Front-loaded turnaround
On the interim earnings call, CEO Tufan Erginbilgic said: “Our early interventions have had a significant and sustainable benefit on our financial results. This is actually in line with my experience of past transformations that suggest the rate of improvement is higher in the early stages“.
Is the bar being set low here again (like his “burning platform” comments when he took over)? Or is this merely an attempt to temper investor expectations?
I’m not sure, to be honest. But I have to believe it’s the latter with the net debt situation. This stood at £2.8bn at the half-year point, down from £3.3bn. But the firm has now offloaded most non-core assets and still has high fixed costs. So the rate of progress will likely slow here, I’d assume.
Its next debt maturity is a €550m bond loan note in 2024, which it expects to pay with underlying cash flows.
Will I top up?
For me, a successful turnaround at Rolls-Royce will mean sustainably higher profits, returning to an investment-grade credit rating, restoring the dividend, and buying back shares (there was massive share dilution during the pandemic).
Despite the early progress, none of those things are looking certain yet. So I reckon it’d be risky for me to buy more shares now, even after the share price correction.
Meanwhile, analysts are expecting full-year earnings per share (EPS) of 9.15p. This puts the shares on a forward P/E ratio of 22, which suggests to me that turnaround optimism is still baked into the share price. That is, they’re not in bargain territory yet.
Looking forward, there are a couple of events that will help me make a more informed decision. These are the firm’s Capital Markets Day at the end of this month and its full-year results in February.
I’m holding tight for now while I look for other opportunities across the FTSE 100.
