Image source: Rolls-Royce plc
Up 125%, the Rolls-Royce (LSE: RR.) share price has been one of the standouts on the FTSE 100 over the past year. It’s been driven by the firm’s impressive turnaround under CEO Tufan Erginbilgic that has been swift and decisive. It’s characterised by tighter cost controls, a focus on high-margin contracts and ambitious plans for the company’s Small Modular Reactor (SMR) nuclear programme.
Subsequently, the company’s order book continues to expand, and investors appear convinced the recovery still has further to run. However, while the rally has rewarded shareholders handsomely, there are some ongoing developments that could change how the story unfolds.
In July, Rolls announced it had sold its UK pension fund to Pension Insurance Corporation in a deal worth £4.3bn, reducing its liabilities and further strengthening its balance sheet. While this is a positive step for long-term financial stability, it could hint towards the end of a decades-old commitment to managing some of its operations internally.
Such action are indicative of the company’s continuing evolution.
Here are a few recent developments that reveal how the aerospace and defence giant isn’t immune to broader industry challenges and global uncertainty.
Supply chain pressures
Globally, aerospace companies are still navigating the aftershocks of the pandemic, and few have done as well as Rolls. But specialist components remain in high demand and short supply, meaning that even with strong order books, engine deliveries and maintenance schedules could be disrupted.
For those that depend on the timely completion of high-value contracts, supply bottlenecks risk denting both cash flow and customer confidence.
Engine maintenance liabilities
A large part of Rolls-Royce’s revenue comes from long-term service agreements, where airlines pay based on engine usage. While this model provides a steady income stream, it also comes with significant obligations.
Unforeseen repair costs, technical faults or accelerated wear can ramp up expenses, pressuring margins in a way that may not be fully visible in short-term earnings reports.
Geopolitical risk
Defence contracts continue to drive growth, as they have for several years, but they depend on political will and budgets. A change in government priorities, export restrictions or diplomatic disputes could see orders delayed or cancelled.
Recently, a swathe of European defence stocks revealed their vulnerability to political developments. On Monday (11 August), QinetiQ, BAE Systems and Babcock International dipped slightly ahead of a meeting between US President Trump and Russian President Putin.
Rolls suffered only minor losses but with a large international footprint, it’s exposed to multiple jurisdictions, each with its own policy risks.
Execution risk in new ventures
The SMR project has the potential to transform Rolls’s long-term earnings profile. But as with any large-scale infrastructure programme, it’s capital-intensive, politically sensitive and still years away from commercial operation.
Delays, regulatory hurdles or shifting energy policy could easily undermine investor confidence.
A solid pick nonetheless
The Rolls-Royce share price has been propelled by genuine operational improvements and a clearer strategic vision. Considering the challenging environment it faced, it has done surprisingly well to turn things around.
And after detailing all those risks, I still believe it’s worth considering, as the potential rewards could justify them – especially for long-term investors prepared to accept some volatility.
But as always, investors should keep in mind that while the rally may continue, no stock is entirely risk-free.
