The Rolls-Royce (LSE:RR) share price is up 35% since the start of the year. But the last month hasn’t been so impressive.
As a number of issues have emerged for the business, the stock’s fallen by 3%. I think this is a buying opportunity for the long term that investors should seriously consider.
Short-term issues
Rolls-Royce has started to come up against some issues. These aren’t major enough to cause the stock to fall significantly, but they’re sufficiently important to stall its momentum.
One is the company’s bid to support the UK’s nuclear power expansion. Delays to the government’s decision about who to partner with have forced the business to scale back its ambitions.
Another is the fact workers at Rolls-Royce’s nuclear submarine programme are taking industrial action. The dispute is over pay and resolving the issue could cause costs for the company to rise.
Neither of these is positive news and investors will want to keep an eye on the situation. The long-term plan for the business looks like it’s on track though.
Positive signs
Analysts believe the company’s on track to pay a dividend this year. And there’s also been positive news for the underlying business.
The commercial aerospace part of the business – which accounts for 45% of total sales – is going strong. The firm’s expanding its capacities in Turkey, where it already has an established presence.
Furthermore, the UK is increasing its defence spending. As a member of NATO, Britain’s required to spend 2% of its GDP on defence, but the government intends to increase this to 2.5%.
Whether or not that’s a good idea politically, Rolls-Royce stands to benefit. Defence accounts for around 25% of the company’s revenues, so a growing market is a positive.
Valuation
The market is focused on the external environment. But I think Rolls-Royce’s growth can be powered by improvements to its balance sheet.
At the end of March, Fitch increased the company’s credit rating and indicated that it expects to do so again. This should help the firm pay less in interest, causing margins to expand.
Rolls-Royce’s management thinks the business can eventually generate £3bn a year in free cash. If this is correct, there’s still a margin of safety in the share price.
The company currently has a market-cap of £34bn. For a business that’s going to generate £3bn in cash that can be returned to shareholders, that’s not a huge price.
Still a buy?
Every business has its ups and downs, but I don’t see anything that’s likely to derail Rolls-Royce’s long-term growth ambitions. As a result, I think investors should consider buying the stock.
A significant fall in the share price would generate a more attractive opportunity. But the company’s ambitions show there could well be plenty more still to come from its shares.
