I think the past few weeks of political chaos might have provided investors with a useful service. I wonder if it’s given depressed FTSE 100 shares an unexpected shake-out, showing which are more vulnerable to further economic fears? If so, I don’t think Rolls-Royce (LSE: RR) shares have come out of it too badly.
What do I mean? Well, apart from a few minor wobbles, the Rolls-Royce share price has resisted further falls in the couple of weeks following that ill-fated mini-budget.
It’s times like this that I remember my favourite quote from ace fund manager Sir John Templeton, who said “The time of maximum pessimism is the best time to buy“.
We’ve certainly been through some pessimistic times over the past few years. But it’s hard to think of a time when more financial weeping was done, or more teeth were gnashed, than October 2022.
Downside?
To me, this all makes the potential downside of an investment in Rolls-Royce look more palatable. For most of the past couple of years, I’ve felt sentiment towards the aero engine maker was shaky at best. And several times, it’s only taken a bit of bad news for investors to sell and flee.
Saying that, there is still significant risk, and I’m not sure if Rolls fits in with my personal appetite for it. I still see debt as the biggest threat. At the end of the first half, at 30 June, Rolls-Royce was still shouldering £5.1bn in net debt. And it still reported net cash outflow — though greatly reduced, at just £77m.
Since then, though, the company has completed the sale of ITP Aero, which raised €1.6bn (£1.4bn at current exchange rates). The cash was earmarked for paying off loans. So I expect to see a significant improvement in the debt situation by the end of the year.
Outlook
On the upside, valuations based on forecasts are starting to look reasonable. This year’s price-to-earnings (P/E) multiple won’t be great, not when profit is only just returning.
But analysts expect decent earnings growth in the next couple of years, which would bring the P/E down around 10.5 by 2024. Adjusting for debt gives an enterprise value P/E of around 17-18, which doesn’t look as attractive. But that’s using an estimated net debt figure for today. And the balance sheet will presumably look better by 2024.
Of course, analysts’ forecasts are uncertain, and plenty could still go wrong in the next two years. But I can’t help wondering how 2023 and 2024 could possibly be anywhere near as bad as the years Rolls-Royce has just suffered. Hmm, I do hope those words don’t come back to bite me.
Verdict
So what’s my verdict? I still see a fair bit of risk with Rolls-Royce shares even at today’s possible ‘maximum pessimism’ valuation. But I can’t help feeling the tide might be turning.
I won’t invest, myself. But that’s because I see more attractive FTSE 100 buys out there with less risk.