Back in January I tipped shares in Rolls-Royce (LSE: RR) as a long-term buy at 1,246p. This now looks like an embarrassing mistake, because the company has announced two profits warnings since then.
In hindsight, I can see that saying “buy” back then was a risky thing to do. Rolls-Royce’s share price had more than tripled in the previous five years and was trading on a punchy multiple of nearly 17 times forecast earnings. There was little protection against things going wrong.
And go wrong they have. The latest kick in the teeth came last week when the company said that profits would be lower than it had previously thought they would be – again!
City analysts who were expecting earnings per share for this year of 73.7p back in January are now expecting something closer to 65p. A weaker economy and the impact of sanctions on Russia are apparently to blame for the decrease.
Rolls-Royce also gave its thoughts on how profitable its business would be in a few years’ time. It tried to reassure investors that it will be making more money then, but it seems the continued promises of ‘jam tomorrow’ are beginning to wear a bit thin.
The shares were understandably dumped by investors. After all, if management can’t predict what profits will be a few months in advance, why should it be able to predict them a few years out?
On the other hand, the company has a big order book of civil aircraft engines from Boeing and Airbus, alongside the thousands already in use.
This means Rolls-Royce should have a decent shot at working out how much money it will make from new deliveries, spare parts and maintenance work. However, the outlook for products that are sold to mining and energy companies is less certain.
In a mess
All in all, Rolls-Royce is in a mess. It is arguably trying to do too much and this is detracting from the attractions of its aircraft engines business. And even this aircraft business is struggling to match the profitability of rival General Electric.
So what should you do with the shares? At the risk of looking foolish again, I’d say that they are much better value now, given the much reduced rating of 12.5 times forecast earnings.
The current management looks like it is skating on thin ice. If it can’t sort things out, then someone else might. Selling off the peripheral bits of the company could make Rolls-Royce look a lot more attractive to investors.
Verdict: buy