Image source: Rolls-Royce plc
If the experts are right, the Rolls Royce (LSE:RR.) The stock price could rise 4.9% over the next year. That’s because the consensus (median) forecast from the analysts covering the stock is 555p. However, this convergence, close to the current (November 20) share price of 529p, masks significant variation in views.
One ‘expert’ believes that a fair price is 240 cents.
Another analyst believes a figure of 701 pence is justified.
Put another way, the most optimistic people believe that the 33% of the company ($14.9 billion) is undervalued, while the most gloomy argue that the 54% ($24.3 billion) is overpriced. Clearly neither of them can be right.
And this illustrates why I find investing in the stock market so fascinating. It intrigues me that two seemingly well-informed individuals, looking at the same financial information and other data, could come to such opposing views.
Yin and yang
With a price target of 240 cents, Berenberg’s pessimism stems from the belief that the expected margin improvement through 2027 could reverse thereafter.
Reference is also made to “reliability problems” a concern for the main engines. It is concerned that the company’s Trent XWB-97, which powers the Airbus A350-1000, has experienced problems. And the commercial bank “surprised at how optimistic the market is on these issues”. It says: “If history is any guide, this is the kind of issue that could derail the medium-term margins of companies in the jet engine sector.”
Others, on the other hand, see a continued increase in flying hours post-pandemic as a catalyst for growth.
As the table below shows, these have yet to match their 2019 peak. But the company’s target for 2024 is 100%-110% of this number.
| Year | Great engine flight hours (M) |
|---|---|
| 2016 | 11.2 |
| 2017 | 12.6 |
| 2018 | 14.3 |
| 2019 | 15.3 |
| 2020 | 6.6 |
| 2021 | 7.4 |
| 2022 | 10.0 |
| 2023 | 13.5 |
Source: company annual reports
And looking further ahead, the company’s growth prospects appear encouraging.
It is making good progress with its factory-built nuclear power plants (small modular reactors). The Czech government has already chosen the British engineering giant as a partner to develop the new technology, with Sweden and the Netherlands expected to follow soon. However, no significant revenues are expected before 2030.
Expected earnings growth
The analysts expect an earnings share (EPS) of 29.3p in 2027. This implies a future price-earnings ratio (P/E). of 18. This is not unreasonable for a fast-growing engineering-cum-technology group.
But based on the expected earnings per share for 2024 of 18.7, the price/earnings ratio rises to an expensive 28.3.
However, if this is applied to the 2027 earnings forecast, this would result in a share price of 829p. Based on this, the forecast of the most optimistic analysts (701p) seems very reasonable.
| Year | Expected earnings per share (pence) | Expected dividend per share (pence) |
|---|---|---|
| 2024 | 18.7 | 5.0 |
| 2025 | 21.9 | 7.1 |
| 2026 | 25.6 | 9.5 |
| 2027 | 29.3 | 11.0 |
Source: Rolls-Royce website
A total of thirteen analysts advise their clients to buy Rolls-Royce shares, including six who consider it a ‘strong buy’. Three are neutral and one recommends selling.
My verdict
I already own shares in the company, but I don’t want to increase my position any further.
In my opinion, the rapid rise in the company’s share price is unlikely to continue. Given the strong recovery in flying hours, I suspect that future growth will likely be more modest.
And I try not to concentrate too much of my portfolio in stocks with stingy dividends. A return of less than 1% is not exactly attractive. I prefer to use my excess cash on stocks that offer returns closer to the FTSE 100 average 3.8%.
For these reasons, I will maintain my position at current levels.
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