Rolls-Royce (LSE: RR) shares have been on stockbroker Hargreaves Lansdown‘s list of most-bought shares for weeks. But the tide seems to be turning.
Although many Hargreaves investors are still buying Rolls’ stock, even more appear to be selling the aero engine-maker. Rolls-Royce was said to be the most-sold stock on Hargreaves’ platform last week.
Rolls issued a trading update on Friday that sent the shares lower, deepening the recent sell-off. But in this piece, I want to revisit the stock and explain why I believe the shares could be cheap at current levels.
Why sell now?
Rolls-Royce shares have bounced from a low of 39p at the start of October to around 120p today. But the shares are already down by more than 10% from the high of 135p seen on 3 December. I can imagine that traders who have profited from the vaccine rebound might be tempted to take profits.
I try to take a long-term view when buying and holding shares. The Rolls-Royce share price has hopefully bottomed out, but the company has barely even started on its recovery journey.
For this reason, I wouldn’t be selling the shares just now. Indeed, I can see a number of reasons why I might consider buying them.
Still on target for 2021
Back in October, Rolls raised £2bn by selling new shares in a rights issue. This was part of a refinancing plan designed to support the company until it becomes profitable again.
Since then, we’ve seen much of Europe go back into various forms of lockdown, including the UK. According to the firm, this has resulted in another reduction in flying hours by aircraft using its engines.
Management now expects airliner flying hours in 2020 to be slightly lower than expected. This means that cash losses for the year will also be a little higher than expected
This isn’t great news. I think it probably triggered Friday’s sell off, which saw Rolls-Royce shares fall by as much as 10%. However, in the grand scheme of things, I don’t think it’s a big deal.
Personally, I’m focused on the firm’s targets for 2021 and 2022. These are unchanged and suggest to me that Rolls shares look quite affordable at current levels.
Are Rolls-Royce shares cheap?
The company says that it still expects to start generating cash during the second half of 2021.
In 2022, management believes that the business could generate around £750m of surplus cash, known as free cash flow. Based on the group’s current valuation, I estimate that this gives the stock a 2022 forecast free cash flow yield of around 7.5%. That’s a fairly attractive figure, in my view.
I’m also bullish about Rolls for a second reason. The group’s jet engine business is going through a difficult period. But its defence and power systems divisions are doing much better. Trading appears to be fairly stable this year, with a number of new contract wins.
I think that Rolls CEO Warren East is doing all the right things. The airline industry and its suppliers are at the bottom of the cycle now, but I expect a gradual recovery from summer 2021. I think that Rolls-Royce shares probably offer good value on a three-to-five year view. I’d be happy to buy some today and tuck them away for a few years.