Rolls-Royce Is a Good Value Stock to Buy and Bet on Turnaround

By

Apr. 26 2021, Updated 8:52 a.m. ET

So far, Rolls-Royce (RYCEY) stock is down 8.9 percent in 2021. The stock’s woes haven't ended even though many other beaten-down industrial names have recovered. However, RYCEY stock looks like a good value stock to buy now and bet on the turnaround.

Article continues below advertisement

To be sure, RYCEY’s woes didn't start in 2020. The stock has been falling since it peaked in 2014. The stock trades at only about 7 percent of what it used to trade in 2014. The stock fell sharply in 2019 and 2020 and is now down YTD in 2021 as well. 

RYCEY stock outlook

To gauge the outlook for RYCEY stock, we’ll have to look at the forecast for its business segments. Rolls-Royce has three main business segments. Civil Aviation, its largest segment, accounted for 41 percent of the revenues in 2020. Unfortunately, the segment has also been impacted the most by the COVID-19 pandemic.

Article continues below advertisement
rycey stock price is falling
Source: Koyfin

Defense, the company’s second-largest segment, accounted for 29 percent of its 2020 revenues. Power Systems is Rolls-Royce’s third-largest segment. For Rolls-Royce, 22 percent of its 2020 revenues came from the third segment. 

Article continues below advertisement

Rolls-Royce will sell ITP Aero.

ITP Aero accounted for 6 percent of RYCEY's 2020 revenues. RYCEY has put the business on the block for sale and is expected to garner around $1.8 billion from the asset. However, the sale would have to be approved by the Spanish government. Reports suggest that the government might block the sale if the conditions aren't met.

Article continues below advertisement

The Civil Aviation segment bore the brunt when aircraft were grounded globally in 2020. Along with the sales of new engines, the segment also generates revenues from servicing aircraft, which is closely tied to flying hours. After the slump in 2020, the outlook for the civil aviation industry is cautiously optimistic.

RYCEY's long-term forecast and turnaround

In 2022, Rolls-Royce expects to generate positive free cash flows of over $1 billion. The forecast is based on the assumption that flying hours recover to more than 80 percent of the 2019 levels and widebody aircraft deliveries of between 200 and 250.

Article continues below advertisement

Also, RYCEY has raised considerable cash in 2020 that would help it survive the current slump. It has also managed to extend its debt maturity profile and most of its debt is maturing after 2025.

Rolls-Royce has also structurally lowered its cost base including through headcount reduction. This would mean structurally higher earnings for the company when it recovers from the current slump.

Article continues below advertisement

The company expects its Power System segment’s revenues to rise to 2019 levels by 2022 and expects margins to rise to 10 percent that year. The Defense segment also looks well placed as higher defense spending globally, including in the U.S. and Europe, would mean higher revenues for the segment.

Article continues below advertisement

Meanwhile, the Civil Aviation segment is a play on the post-pandemic economic recovery. While the COVID-19 pandemic is still far from over considering the spike in India and Brazil, the increasing pace of vaccinations would help address the situation in the medium term.

RYCEY looks like a good value stock to buy now

RYCEY stock trades at an NTM EV-to-sales multiple of 1.05x. The multiples look decent enough. Incidentally, while most other beaten-down value and industrial stocks have bounced back including OEMs like Boeing and Airbus, RYCEY hasn’t seen that kind of rerating.

Article continues below advertisement
rycey stock undervalued
Source: Koyfin

However, the stock looks like a good way to play the recovery in the aviation sector, which should rebound after the conditions recover to a more normalized level. While there are risks of the COVID-19 pandemic stretching more than what the markets are currently envisioning, at the current prices, RYCEY looks like a good value stock to buy now and bet on the turnaround.

Advertisement

More From Market Realist

  • Shipping vessel with goods
    Industrials
    CTRM Stock Forecast: Don't Expect a Recovery to $1 Anytime Soon
  • Chefs at work in a kitchen
    Industrials
    Should You Buy Welbilt (WBT) Stock After Middleby Deal
  • CTRM ship
    Industrials
    Avoid CTRM Stock Even Though Dry Bulk Sector Shines
  • Cleveland-Cliffs building
    Industrials
    CLF Stock Is a Good Buy as the U.S. Steel Cycle Nears Its Peak
  • CONNECT with Market Realist
  • Link to Facebook
  • Link to Twitter
  • Link to Instagram
  • Link to Email Subscribe
Market Realist Logo
Do Not Sell My Personal Information

© Copyright 2021 Market Realist. Market Realist is a registered trademark. All Rights Reserved. People may receive compensation for some links to products and services on this website. Offers may be subject to change without notice.