Despite hitting a record high, analysts reckon Rolls-Royce shares are still undervalued

On 10 June, the Rolls-Royce Holdings (LSE:RR.) share price reached an all-time high of 912.6p. Since then, it’s fallen back a little but it’s impossible to deny that the group’s post-pandemic recovery has been remarkable.

It’s hard to believe that when the aerospace giant announced its life-saving rights issue in October 2020 — which was priced at 32p a share — it had a market-cap of £1.5bn. Today (18 June), it’s worth over £75bn.

Not finished yet

But analysts reckon there’s more to come. Their 12-month share price target’s 920p — 2% more than today’s price. The most optimistic reckons the company’s 28% undervalued.

Those assessing the group’s prospects are forecasting earnings per share (EPS) of 37p by 2028. This means the stock’s currently trading on 24 times forward earnings. Although the stock isn’t cheap, valuations at this level aren’t unusual for a group that’s growing rapidly.

If the ‘experts’ are right, underlying EPS will have grown by 61% compared to 2024. That would be an impressive average annual growth rate of 17.3% and helps underpin the above-average multiple.

Encouragingly, this increase in profit is expected to be spread evenly across the group’s three principal divisions with Civil Aerospace continuing to be the biggest contributor. In 2025, it’s forecast to account for 60.8% of underlying operating profit rising to 61.7% by 2028. Over the same period, Defence is expected to drop by two percentage points and Power Systems is predicted to dip by just under one point.

Looking ahead

Air passenger numbers are expected to grow over the coming decades, which should increase the demand for new engines and boost flying hours. And I wonder if we might soon see an upgrade in the Defence division’s earnings forecast, given the pledges made by European governments to increase military spending.

Much has been made of the recent announcement that Rolls-Royce has been chosen by Great British Nuclear to deliver three small modular reactors (SMRs) — factory-built mini nuclear power stations – as part of a £2.5bn programme.

The group’s chief executive says SMRs will “create significant long-term value”. However, the first electricity creation isn’t expected until the mid-2030s. Initially, 2030 was suggested. Other overseas opportunities may deliver earlier. But while I’m an advocate of long-term investing, I don’t think many investors have priced SMRs into their assessment of the group’s worth. This could change as we approach the end of the decade.

Back down to earth

Despite the group’s impressive performance, the pandemic reminded us how sensitive its earnings are to an aviation industry downturn. Hopefully, we won’t experience anything like Covid-19 again but other issues could reduce the number of aeroplanes in our skies.

Also, the company’s dividend lags some of its FTSE 100 peers. It’s currently yielding just 0.7%.

Of course, these forecasts may prove to be inaccurate. But the group’s recent performance suggests they’re attainable. With a long history, Rolls-Royce has a reputation for engineering excellence and it operates in three sectors that are all growing rapidly.

We will know if everything’s on track when its half-year results are announced on 31 July, although I’m mindful that any sign of weakness could have a big impact on the group’s share price.

However, on balance, I think Rolls-Royce remains a stock for growth investors to consider.

The post Despite hitting a record high, analysts reckon Rolls-Royce shares are still undervalued appeared first on The Motley Fool UK.

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James Beard has positions in Rolls-Royce Plc. The Motley Fool UK has recommended Rolls-Royce Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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