Image source: Rolls-Royce plc
Despite fears of a slowdown following the recovery of the air travel market, the Rolls-Royce (LSE:RR.) share price continues to defy expectations and rise to new all-time highs. The engineering giant recently surpassed the 900p stock price threshold for the first time this month as a brand new catalyst emerged from China.
US tariffs were initially expected to be enormously problematic for this enterprise. But following the new UK-US trade deal that allows Roll-Royce to export its engines and aircraft parts tariff-free, those concerns were quickly eliminated. But that’s not what seems to have investors excited.
With trade tensions on the rise between the Trump administration and Beijing, Bloomberg has reported that China’s considering making a large order of up to 500 Airbus planes from France rather than from Boeing in America.
That’s significant for Rolls-Royce since its engines are used on a number of Airbus’ wide-body engines. And it puts the company in a lovely spot to benefit greatly from this deal, not just in terms of selling more engines but also the long-term revenue for servicing them throughout their operational lifetime.
More growth to come
Even after delivering a massive 860% return for shareholders since the start of 2023, it seems the aerospace stock may still have room to grow. Bank of America’s placed its share price target at 1,150p by this time next year, citing management’s mid-term targets of reaching £4.2bn-£4.5bn in free cash flow. And compared to where the stock’s trading right now, that translates into a 28% potential gain.
This volume of free cash flow also paves the way for substantially higher dividends. A payout of 6p a share was already issued earlier this year, ending the company’s five-year dividend hiatus. But looking out to 2026, analysts have projected the Rolls-Royce dividend could reach around 9.7p.
If these projections prove accurate, it places the forward yield just shy of 1.1%. Obviously, for income investors, that’s hardly groundbreaking. After all, even a FTSE 100 index fund currently offers three times that amount. However, in the long run, if the group’s free cash flow continues to surge, future dividend hikes might enable the current yield to grow into something far more substantial over time.
What could go wrong?
There’s a lot of optimism surrounding this business today. However, that doesn’t mean it’s guaranteed to deliver on the positive investor sentiment. And even Bank of America has flagged several weak spots.
Last year, concerns surrounding the reliability of its XWB-97 engine started to emerge as an in-flight engine fire for a Cathay Pacific flight to Hong Kong forced an emergency landing. Following this incident, the European Aviation Safety Agency issued an airworthiness directive mandating that all XWB-97 engines needed to be inspected.
Analysts also pointed out Rolls-Royce’s involvement in several complex projects, such as its small modular reactors and its UltraFan engine. Considering these technologies could be the key to the company’s long-term growth, any failure or delays during development could affect its financial performance.
All things considered, I think there are more reasons to be optimistic than pessimistic for this business. Even more so when factoring in management’s knack for defying expectations. That’s why, despite the tremendous growth seen to date, investors may want to consider taking a closer look.
