Image source: Getty Images
Rolls-Royce’s (LSE: RR) share price has tumbled 18% from its 19 March one-year traded high of £8.18. Much of this fall followed US President Donald Trump’s 2 April rollout of 10% tariffs on UK imports into the country.
Higher tariffs will be applied on goods from around 60 countries and/or trading blocs claimed to show a high trade deficit with the US. These include China (now 104%) and the European Union (20%).
My key question when a stock has fallen in such circumstances is whether it is worth me buying on the dip. So I took a deep dive into the business and ran the key numbers to find out if it is.
How will the tariffs affect the firm?
I think it critical here to clarify that the Rolls-Royce shares quoted in the FTSE 100 relate to the firm’s aerospace, defence, and power systems businesses. So these are subject to the standard 10% tariff applied to the UK.
Since the licensing of the name rights in 1998, Rolls-Royce Motor Cars is unconnected to the UK-listed firm. It is a subsidiary of BMW (and in this context, all automobiles are now subject to 25% tariffs when imported into the US).
That said, the US tariffs on the listed Rolls-Royce business are a risk for its share value over time. This is broadly derived from the earnings a company is expected to generate in the future.
The company has significant operations in 27 US states, which provides it with additional supply and production capacity in-country. Rolls-Royce stated recently that it will use this: “To ensure our global internal supply chain is optimised for delivery to customers in the US”.
Was the business in good shape before?
I think broadly that the stronger a business was at the onset of the tariffs, the better positioned it is to handle them effectively.
In Rolls-Royce’s case, it looked very strong to me, with revenue rising 16% year on year to £17.848bn. Operating profit leapt 55% to £2.464bn over the same period, and free cash flow soared 89% to £2.425bn.
At that point, the firm forecast a 2025 underlying operating profit of £2.7bn-£2.9bn. It also projected free cash flow of the same £2.7bn-£2.9bn in the year.
These strong numbers enabled it to announce a £1bn share buyback this year, with buybacks tending to support stock prices.
As of now – with the tariffs news included – analysts forecast its earnings will grow 3.2% annually to end-2027.
So how does the share valuation look?
Rolls-Royce looks cheap on the key price-to-earnings ratio at 22.6 against a competitor average of 29.2. These comprise Northrup Grumman at 17, BAE Systems at 24, RTX at 33.7, and TransDigm at 42.
The same is true of its price-to-sales ratio of 3 compared to its peer group average of 3.5.
I ran a discounted cash flow analysis to nail down what this means in share price terms. The results show that Rolls-Royce stock is 49% undervalued at its current £6.72 price.
Therefore, the fair value for it is technically £13.18, although share prices can go down as well as up.
I think there is just too much value in the stock for me to ignore now, so I will buy it very shortly.
