What is the Rolls-Royce share price really worth?

Over the past five years, the Rolls-Royce (LSE: RR) share price has been on a bit of a roller-coaster ride. It surged to 375p in August 2018 before plunging to a low of 40p in October 2020. 

Since then, the stock’s recovered some losses. Last week, it was changing hands at around 112p, that’s up 45% from the September 2020 level of 77p. 

After looking at the performance of the company’s shares over the past five years, I’ve been starting to wonder just how much the stock could be worth.

Following the challenges of the coronavirus pandemic, it’s clear the business is worth less today than it was three years ago. 

However, this is still one of the world’s premier aerospace engineers, which owns incredibly valuable technology and even supplies nuclear reactors for the Royal Navy’s submarines. 

And based on these factors, I think the Rolls-Royce share price could be worth significantly more than the market’s currently willing to pay. 

International comparisons

This year, there’s been a surge in demand for UK companies from overseas buyers. Meggitt, Ultra Electronics and Senior have all attracted interest from international competitors, and some of these prospective purchasers have been willing to offer significant premiums. 

I think it’s unlikely Rolls will suffer the same fate as the UK government still owns a “golden share” in the enterprise, which may prevent any takeover. 

Nevertheless, these deals give us some idea of how much the Rolls-Royce share price could be worth. 

In the three situations above, buyers were willing to pay an average of 26 times free cash flow for these businesses. I’ve used a five-year average free cash flow figure for Meggitt in this example as, last year, the company saw a sudden drop in cash flow.

This valuation’s roughly similar to the US defence sector as well. 

Rolls-Royce share price potential 

Rolls believes it can generate a free cash flow of £750m per annum as early as 2022. If the organisation hits this target, and assuming it can achieve a valuation of 26 times free cash flow, my figures suggest the company’s market value could hit £19.5bn. At the time of writing, it’s worth just £13bn. 

Of course, this is a big IF. Rolls has a history of missing forecasts. It also assumes the global aviation industry recovers quickly after the pandemic. And we know that’s far from guaranteed. 

Further, this assumes the market’s willing to pay an industry average multiple for business. That may not happen at all. However, I think these figures illustrate the company’s potential in the best-case scenario. 

Still, despite this potential, I wouldn’t buy the stock for my portfolio today. I think the risks of the company not hitting its free cash flow target are just too high.