Rolls-Royce (LSE: RR) shares have fallen 75% over the past five years.
But I think Rolls is essentially sound. With its engines installed in so many of the world’s aeroplanes, nobody is likely to steal its business tomorrow.
Even a doubling of the Rolls-Royce share price would still only return it to early pandemic levels.
It all depends on timescale, and I don’t see it happening any time soon. In the next five years though, I think it’s a genuine possibility. What might the numbers look like?
Popular measures used to value shares, like the price-to-earnings (P/E) ratio, are tricky right now. What does a trailing 12-month P/E of 40 mean, when we’re in the middle of rapid change? Even 2022 forecasts don’t add much as ratios can be meaningless in a loss-to-profit transition period.
Attractive forecasts
But if I check broker forecasts beyond this year, things start to look good. Analysts have the Rolls-Royce P/E coming down to around 11 by 2024. Yes, that’s still two years out. And we’re heading into a recession. So there’s a fair bit of uncertainty there.
But it compares well to the FTSE 100‘s long-term average of around 15. To hit the average, the share price would need to rise by 35%. And if earnings growth is back on, I reckon Rolls shares could command a premium by then. Perhaps we might even see a 50% hike over today’s price?
I reckon steady earnings growth could bring that P/E down to well below 10 by 2027. And we could then be looking at a share price doubling just to reach average FTSE 100 levels.
Enterprise valuation
I see another valuation trend that I like, and that’s enterprise valuation (EV). Investors often look at a company’s market capitalisation as an overall measure of its value. And the Rolls-Royce market cap certainly dropped in the pandemic.
But a market cap comparison doesn’t reflect the billions of extra debt. If we add net debt to market cap, we get a valuation of the company plus what it would take to pay the debt — the EV.
In 2021, Rolls was on an EV that was even higher than before the pandemic. Through 2022 though, it’s falling, and analysts expect that to continue, some of it is a result of lower share prices. And some is down to Rolls disposing of non-core assets and starting to repay debt. A deflated EV has to be good.
Can I lose?
But I can’t consider the question of doubling my money without asking a related one. Could I halve my money with Rolls-Royce shares?
I think the answer is yes, I could, especially in the short term. I do think aviation will get back to strength. But depending on the length of our apparently inevitable recession, it could take longer than we hope.
I also expect a significant defence boost for Rolls-Royce in the coming years. But again, the timescales for such things can be slow.
If Rolls-Royce should need more cash at any stage, we might see another share price collapse. So, there’s short-term danger. But I think Rolls could be a long-term buy for patient investors like me.