After breaking 150p, are Rolls-Royce shares still undervalued?

Rolls-Royce (LSE: RR) shares among the most traded in the FTSE 100. For some investors, this is an obvious value pick. For others, it is a debt-ridden company with an uncertain future. And this creates volatility.

To put that in perspective, the stock is up 118% in six months, up 44% in one year, and down 50% in five years.

Then what else? Is Rolls-Royce still undervalued?

What analysts think

Earlier in March, the Swiss bank UBS told investors that Rolls shares “abnormally cheap“.

The bank said:Despite a more than 40% move in share price since Q4 results Rolls is still trading almost 2pts below historical results on circa 9% consensus 2024 estimated free cash flow“.

This was followed by an upgrade, with UBS almost doubling its price target, to 200p from 105p.

But UBS is not the only bank with a positive outlook on the British engineering giant. Citi raised its price target on Rolls-Royce in mid-March to 255p as quoted “clear route to better cash flow“.

So as Rolls shares were pushed above 150p this week for the second time this year, further growth could be on the cards.

Can it push the Rolls up?

The recovery in civil aviation was the main factor that brought the share price up to date. But investors are struggling to understand how they can improve.

The reopening of China is another factor in this. This is because you cannot find Rolls-Royce engines on flights in Europe. But in China, wide planes with two aisles and Rolls-Royce engines are used for short-haul routes.

China, according to UBS, accounts for a 40% decrease in wide body traffic in 2022 compared to 2019.

The data has been positive since the reopening of China. In February, passenger traffic increased by 38% year-on-year. International passenger traffic is up 756% – although that’s not surprising, given that China was locked away from the rest of the world a year ago.

We also know that two other business segments – power systems and defense – are generating steady growth.

The biggest concern in debt. Net debt has reduced significantly, but is still a worrying £3.3bn.

The top performer?

There is a strong possibility that the company can become the top player in the FTSE 100 in 2023. After all, it has been an immensely strong start to the year.

I don’t see much movement in the stock price until we see some more data on the company’s post-pandemic recovery.

However, I am confident that Rolls’ recovery will continue, with earnings expected to reach 2019 levels, despite being a smaller and leaner company today. I believe the stock is undervalued.

I have a fairly significant holding in the stock. And on this occasion, I really didn’t buy anything else. The reason is simply because I see greater value in financial stocks at this time – after the collapse – and I have limited capital.