A friend once noted that I was good at buying shares after they’d already risen. So why am I looking at Rolls-Royce Holdings (LSE: RR.) shares today and feeling bullish?
The share price has almost trebled in the past 12 months. It’s still down 34% in five years though. But it’s not the same company it was before the crash.
My problem has always been the valuation of Rolls-Royce stock and trying to balance it against the company’s debt.
There’s a forecast price-to-earnings (P/E) ratio of 31 for the current year, which looks high. Still, with earnings growth on the cards, it could be fine.
The net debt figure of £2.8bn throws it off a bit, but actually not by a lot. For a company with a market-cap of £18.8bn, it’s a relatively small proportion.
Perhaps, ironically, the rise in the Rolls-Royce share price has helped make the debt figure look less worrying.
That’s better than it might sound, if the earnings are there to cover the valuation gains. Adjusting the P/E to account for the debt pushes it up to about 35.5. A bit high?
Well, analysts expect earnings before tax at Rolls to soar by more than 70% by 2025. That would drop the headline P/E to about 17.5 — or about 20 on a debt-adjusted basis, if debt didn’t change by then. I think that’s attractive.
One worry is that a chunk of debt is due for repayment by 2025. So if the travel business doesn’t recover as quickly as expected, and cash flow isn’t what we hope, that might hit the stock price.
It’s not like international relations are going swimmingly well right now, so it has to be a real risk.
Then again, should Rolls need new loans to pay off some of the old debt, it might not have too hard a job getting them. The firm isn’t back at an investment-grade credit rating yet, but I doubt most lenders would worry too much.
So my main worries really don’t seem so bad when I examine them more closely.
The headline Rolls-Royce share valuation looks high. But going on forecasts, it could actually be cheap. The City is pretty bullish overall.
Debt has been a big concern. But it’s really not that high for a company of this size. Compared with BT Group, for example, BT’s net debt exceeds its market-cap by some margin.
I have this nagging feel that Rolls-Royce shares might, at least, be one of the FTSE 100’s best buys now. So why won’t I invest?
I think back to the times I’ve bought a growth or recovery stock, on a high headline valuation. On average, they didn’t do well.
The whole market seems to be behind Rolls-Royce now. But when everyone is buying a stock, I reckon that’s usually a good sign to stay away. For now, at least.
I just think there could be better times to buy ahead.
Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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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