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Rolls-Royce share price is 21% undervalued. Is it a good buy?

Rolls-Royce (LON: RR) share price has crawled back in the past few days as investors reflect on the company’s recent first-half earnings. The stock rose to 85.47p, which was higher than last week’s low of 80.06p. 

Recovery is facing headwinds

Rolls-Royce Holdings is going through an exciting period as key segments of its business rebound. Civil aviation, which accounts for over half of its total revenue, has bounced back well in the past few months. Results by some of its key customers like Lufthansa, Cathay Pacific, and Emirates have shown that the industry is in a recovery mode.

Its defense contracting business is also in a recovery mode due to Russsia’s invasion of Ukraine. Many western governments have announced plans to boost their defense spending in the coming years. Nato is also expanding, with countries like Sweden and Finland set to join.

The power industry is also seeing a strong comeback as the transition to clean energy faces major headwinds. 

However, Rolls-Royce is still facing numerous challenges, especially on costs. Last week, the company said that its underlying profit declined to 125 million pounds from 307 million pounds a year earlier. The profitability was about 24% lower than what analysts were expecting. 

In total, the company made a loss of over 111 million pounds. Still, the management believes that the company will come back to profitability in the second half of the year. Other catalysts for the company will be its growing free cash flow, a strong order intake in its power business, and an increase in revenues.

Still, analysts believe that Rolls-Royce’s share price is severely undervalued. Its price-to-sales ratio of 0.6x is significantly lower than the industry average of 2.4x. At the same time, a discounted free cash flow (DCF) calculation showed that the stock was undervalued by about 21%.

Rolls-Royce share price forecast

The four-hour chart shows that the RR share price has moved sideways in the past few weeks. It has remained between the important resistance and support at 94.08p and 78.11p, respectively. The shares have moved slightly below the 25-day moving average while the MACD has moved below the neutral point. 

Therefore, the Rolls-Royce share price will likely remain in this range in the coming weeks. A solid bullish move will be confirmed if the stock manages to move above the resistance point at 94p. A move below the support at 78.11p will invalidate the bullish view.

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