Rolls-Royce shares have been on a bullish run over the past few months, gaining more than 70% in value since the start of the year.
One of the key drivers of the company's share price rally has been the improvement in its financial performance. In the first half of 2021, Rolls-Royce reported a pre-tax profit of £393 million, up from a loss of £5.4 billion in the same period last year. This was mainly due to the recovery in the civil aerospace market, which accounts for the bulk of Rolls-Royce's revenue.
However, despite this improvement, the company's financials are still weak, and it continues to carry a heavy debt burden. Rolls-Royce's net debt at the end of June was £2.2 billion, which is more than six times its underlying earnings. This means that the company will have to keep generating profits and cash flows to meet its debt obligations and invest in new technologies.
Moreover, the civil aerospace market remains uncertain, given the ongoing pandemic and the shift towards sustainable aviation. While the demand for air travel has picked up in recent months, the recovery is not expected to be linear, and there could be setbacks along the way. Also, there is increasing pressure on airlines to reduce their carbon footprint, which could impact the demand for Rolls-Royce's traditional jet engines.
In addition to these factors, the broader market conditions also suggest that Rolls-Royce shares may be overvalued. The UK stock market is trading at historically high valuations, with the FTSE 100 index currently trading at a price-to-earnings ratio of 20.8. This suggests that investors are willing to pay a premium for UK stocks, including Rolls-Royce, which could be unsustainable in the long run.
Overall, while Rolls-Royce's financial performance has improved, the company still faces significant challenges, and the market conditions suggest that its shares may be overvalued