Blue Moon Contrarian opportunity?

I say blue moon because apparently tonight is going to be a blue moon. This is commonly used to represent something which is not seen that often. Apparently in astronomy this relates to the second moon in a month (as per tonight) or the third of four full moons in a season, but don't worry the moon will not actually be blue.

Another saying is in for a penny in for a pound which apparently means if you are owed a penny you might as well be owed a pound. What is he going on about I expect you are wondering already. Well today's idea may be a rare opportunity to buy into a contrarian opportunity for both a short term trade and also for the long term as it is I would say a quality play. However it is not that rare, like a blue moon seemingly, as shareholders in this one have suffered several bad moons recently and in terms of the short term trading opportunity I think you could go in for 9.27 pennies of dividend and be in for a pound of upside.

So what is it I hear you cry. Well it is one of those many companies that reported yesterday so it may have got lost in the rush to the beach by corporate CEO's. Talking of CEO's this one, Rolls Royce (RR), has a new CEO - Warren East who interestingly was the former CEO of ARM Holdings. At least he comes from a technology background although clearly the technology on offer here is at the other end of the scale to that offered by ARM.

Any way I suspect the recent resetting of expectations carried out by the Company was probably done in conjunction with and with him prior to his start date. although I understand he will obviously be reviewing things further before he reports back by the end of the year. But nevertheless given they have had about three profits warnings in the last year I would hope that most of the bad news is now out of the way and that expectations have reached a floor.

Some indication of this came in the update yesterday when Mr East set out their current expectations for this year. In this he suggested they would make £1,325m - £1,475m Pre Tax profits and eps of 55 - 62p. Now obviously they have disappointed several times before so these are not guaranteed, but as least the market is already sceptical because current consensus is for 53.6p of earnings, so there could even be scope for upgrades if they can hit their targets this time.

The other encouraging thing was that the interim dividend was increased by 3% to the 9.27p mentioned above and this compares to consensus forecasts of a flat dividend so again it looks as though expectations had now go perhaps too pessimistic suggesting there could be an opportunity for a turn around in sentiment if they can start to deliver on their expectations.

The other aspects I like about this one apart from the technology they have and the R & D they do is the five year order book that they have plus the big market position they are carving out in the new wide body airliner market. The benefits of this will all be long term and the profits are going to be more back end loaded as they are changing the way the account for the new engines and the resulting spares business. Before this was all bundled and spread over the life which brought forward earning recognition from spares and maintenance, so that is also worth bearing in mind.

Looking at the valuation it is not actually in bargain basement bin, but given the nature of this one I don't think it is likely to get there any time soon. However, it is on a fairish looking 15x or so with a 3%+ yield which is around 2x covered. So OK but not outstanding, but I think this could be a good entry point for a longer term recovery and growth going forwards. They have for example grown their dividend by 9% per annum over the last five years and I see no reason why they should not be able to do something similar going forward given the order book and assuming the short term head winds can be over come.

So what about the short term opportunity? Well I mentioned already you can get the interim dividend of 9.27p (worth 1.24%) and looking at the chart this is where the pound comes in. As we saw earlier in the year when I suggested trading this one on a previous profits warning, this one has been quite volatile but also good at closing its gaps on the chart. The latest warning recently opened up another gap on the chart at just above 850p so at the current price of 750p this to me suggests that there could be 100p (13%) or more of upside too in the short term. I'm also encouraged by the fact that the sentiment is on the floor (see comments about forecasts above) and the shares are heavily oversold. In addition I note the positive divergence on the RSI recently with the stock making new lows but the RSI failing to confirm. This is usually a sign that downside momentum is slowing or is exhausted and after three of four goes like that it is often the pre-cursor to a rally.

So there you go this could be a blue moon opportunity to buy into this one, although like blue moons we have had a couple  of those this year already with this one, but in this case I think it could be a case of a Bad Moon Rising. What's that you do believe that's a song?  Oh go on then have some CCR at the end as well as RR - hope you enjoy them both!