Rolls Royce Shares Still Undervalued, say Analysts

Shares in engine maker Rolls-Royce are still below their fair value, despite a 13% rally today following positive results

Jeffrey Vonk 7 March, 2018 | 2:37PM
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Rolls-Royce Shares Rose 13%

Rolls-Royce reported excellent 2017 results, as profits beat Morningstar analysts’ estimates, driven by strong activity in civil aerospace and power systems.

The company’s shares rose 13% after the engine maker posted pre-tax profits of £4.9 billion for 2017 against a loss of over £4 billion in 2016. Despite the recent strong share price increase, we believe the shares are still undervalued. We are updating our estimates for the latest developments, which will most likely result in a modest increase in our fair value estimate of 970p a share, around 5%. We maintain our narrow moat rating, which means the company has a slender competitive advantage.

In 2017, Rolls delivered 444 wide-body engines at a net cost of £1.6 million per engine. We believe this should improve over the next five years to £400,000 per engine as production of the Airbus A350 and Airbus A330neo ramps up. Strong improvement in 2017 on the Trent XWB-84 engine supports our belief. Higher profits on equipment sales, combined with increased high-margin aftermarket activity, should boost Rolls-Royce's margins beyond 2017.

Our bullish stance on Rolls' civil aerospace division is underpinned by still-growing maintenance activity on older-generation engines of the Trent Family of engines. In 2017, the civil aerospace division, a high-margin service, was driven by both increased engine flying hours and higher time and material activity for older engines. Invoiced flying hours from in-production Trent engines increased 22% in 2017.

Rolls management has also announced a strategic review for its marine segment. We would support a sale of Rolls’ commercial marine operations, given the structurally reduced activity levels in the import offshore market and limited synergies with the rest of Rolls-Royce's activities. Marine’s naval operations, which are more government-oriented, will be integrated into the defence business unit.

 

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Securities Mentioned in Article

Security NamePriceChange (%)Morningstar
Rating
Rolls-Royce Holdings PLC81.21 GBX0.66Rating

About Author

Jeffrey Vonk  is an equity analyst with Morningstar.