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2 undervalued FTSE 100 stocks I’m buying for the recovery!

Smiling black woman showing e-ticket on smartphone to white male attendant at airport
Smiling black woman showing e-ticket on smartphone to white male attendant at airport

There’s no shortage of discounted FTSE 100 stocks right now. While the index has been pulled upwards by oil & gas, and previously mining stocks, this year many companies have struggled.

Rolls-Royce (LSE:RR) and Smith & Nephew (LSE:SN) are among those who have struggled. These FTSE 100 heavyweights experienced challenges, for different reasons, during the pandemic. And 2022 hasn’t provided the respite that many investors expected.

So let’s take a closer look at these two stocks and why I’m buying more of them for my portfolio.

Tailwinds improving

Rolls-Royce shares are down 40% over 12 months. Many investors had hoped that 2022 might be a more promising year after the pandemic saw a sharp contraction in flying hours — a major source of income for the group.

This week, the group announced that large Engine Flying Hours (EFH) are around 65% of pre-pandemic levels in the four months to the end of October. While the recovery has been strong in Europe and North America, China and the ASEAN region as a whole have seen a slower recovery.

But there are positives. Rolls completed a £2bn disposal programme in September, using the funds to pay down nearer-term debt obligations. The firm still has £4bn in debt obligations between 2024-2028, but this is all on fixed-interest rate terms.

EFH should improve month-on-month, especially if China opens up as reports suggest. But other segments — power systems and defence — have been boosted this year. The power systems division has seen orders grow 53% to £2.1bn over 12 months. Meanwhile, the Defence business has reportedly grown on the back of increasing global spending as Putin continues waging war in Ukraine.

I already own Rolls-Royce stock, but I’m buying more as the recovery continues.

Medical device leader

Smith & Nephew shares fell during the pandemic as health services shifted resources to treating Covid over elective operations — this hit the medical device manufacturer hard. As a result, the stock is down 37% over three years, and down 20% over 12 months.

Costs are the new concern for investors, with inflation eating into margins. But there’s definitely defensive qualities here. Health services need the devices the company creates, so it should be able to pass costs onto customers.

There’s a considerable backlog of elective procedures in the UK, and there’s political determination to bring these numbers down.

This week, the firm said that revenue for the quarter came in at $1.25bn, up 4.8% on the same period a year earlier, on an underlying basis. However, exchange rate headwinds resulted in a 1.2% decline on a reported basis.

The forward price-to-earnings ratio for the firm is 13 — that’s not cheap. But there’s significant room for recovery. Revenue is above pre-pandemic levels, but profits aren’t. The firm is going about a business improvement programme and is making progress on reducing its backlog.

I’m buying more shares as, to me, they appear significantly undervalued. It’s current trading with a forward price-to-sales ratio of 1.9, versus a sector average of 4.2.

The post 2 undervalued FTSE 100 stocks I’m buying for the recovery! appeared first on The Motley Fool UK.

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James Fox has positions in Rolls-Royce and Smith & Nephew. The Motley Fool UK has recommended Smith & Nephew. 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 2022