Why I think the Rolls-Royce share price is a FTSE 100 growth bargain
Earnings at FTSE 100 aerospace giant Rolls-Royce (LSE: RR) finally pulled out of a steep three-year dive last year and they’re set to power higher. City analysts are forecasting annual increases in excess of 50% for each of the next two years.
I’ll come back shortly to why I view the stock as a top blue-chip growth buy. First, I’d like to tell you about mid-cap Synthomer (LSE: SYNT), which has been one of the FTSE 250‘s top-performing stocks of the last 10 years.
Synthomer, which released a trading update this morning, provided its investors with an average return of 28% a year over the 10 years ended 31 December. And this year, the shares are up 14% so far, despite a 2% pullback in early trading today.
A speciality chemicals firm, Synthomer is one of the world’s leading suppliers of aqueous polymers. It serves customers in a wide range of industries, its polymers ending up in products as diverse as industrial flooring and medical examination gloves.
In today’s update, management reported that overall group performance in the first quarter of the year had been in line with its expectations. And it said its “full-year 2019 outlook remains unchanged.”
Still very buyable
City analysts are forecasting annual earnings growth of 5%-6%. At a share price of 405p, the price-to-earnings (P/E) ratio is 11.8 based on forecasts for the current year, falling to 11.1 on next year’s forecasts.
Add to the earnings growth a forecast dividend yield of 3.4%, rising to 3.6%, and you’ve got implied annual returns in high single-digits. The P/E is currently modest by the company’s historical standards, so there’s potential for higher returns, if the market decides to revert to a higher rating. The stock remains very buyable at the current price, I’d say.
Rolls-Royce has come through a very difficult few years. Some of the challenges it faced were outside its control, but some can be laid at the door of previous management over a number of years.
When a company as big as Rolls-Royce has to undergo a major restructuring of its businesses, and change in its corporate culture, it takes time. I admire current chief executive Warren East, and the way he’s gone about the transformation, and I see similarities with Tesco boss Dave Lewis and the turnaround of the supermarket giant. Both men were able to hail a breakthrough year in delivering their latest annual results.
Top growth bargain
As you might expect for a company forecast to deliver earnings growth in excess of 50% this year and next, Rolls-Royce’s forward P/Es are significantly higher than Synthomer’s. At a share price of 915p, the aerospace group’s P/Es are 36 and 24.
However, due to the strength of the earnings growth, the price-to-earnings growth (PEG) ratio is highly attractive. Ratios of 0.6 for this year and 0.5 for next, are both deep on the good value side of the PEG fair value marker of 1.
For this reason, I see Rolls-Royce as a top FTSE 100 growth bargain. Meanwhile, its running dividend yield of 1.3% is only modest, but the payout can be expected to rise strongly in the coming years on the back of the anticipated impressive earnings growth.
G A Chester has no position in any of the shares mentioned. The Motley Fool UK has recommended Synthomer and Tesco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
Motley Fool UK 2019