Image source: Rolls-Royce plc
On Wednesday (13 August), the Rolls-Royce (LSE:RR.) share price fell 1.8% despite Tufan Erginbilgiç, the aerospace and defence group’s chief executive, telling the BBC that artificial intelligence (AI) powered by small modular reactors (SMRs) could make it the UK’s most valuable listed company.
But SMRs – factory-built nuclear power stations – are still being developed. Therefore, Erginbilgiç’s looking many years ahead. That’s probably why investors didn’t seem that excited. However, based on current (15 August) valuations, for Rolls-Royce to become the FTSE’s biggest company today, its market-cap would need to be 93% higher.
Is this possible?
The next big thing
Everyone seems to be jumping on the AI bandwagon at the moment. This appears to be driven by predictions that the technology could bring about a fourth industrial revolution.
Like all businesses, AI will probably impact every aspect of the company’s operations. But the boss of Rolls-Royce believes there will be a more significant benefit from the anticipated increase in the demand for electricity needed to power the next generation of energy-hungry AI data centres.
Some numbers
Presently, the group’s shares trade on 29.2 times its forecast 2028 earnings. On this basis, to achieve a valuation 93% higher, it would need to generate an additional £3bn of profit a year.
Given that each SMR is expected to cost over £2bn and that 400 might be needed by 2050, this seems achievable. In addition to the upfront profit, there will also be the opportunity to generate ongoing maintenance revenue. Erginbilgiç claims“there is no private company in the world with the nuclear capability we have“.
However, there are presently no SMRs anywhere in the world generating electricity. The technology remains unproven and — like many nuclear energy projects — may ultimately prove more expensive than initially anticipated.
Personally, I think it could be at least a decade before there’s sufficient visibility on the viability of the technology to have a significant impact on the group’s stock market valuation.
Doing what it does best
More immediately, a move to start fitting its engines to narrow-body aircraft could be more lucrative. This market’s estimated to be nine times bigger than the wide-body equivalent in which Rolls-Royce is believed to be the market leader.
From 2024-2028, analysts are expecting an average annual increase of 13% in operating profit from its civil aerospace division.
If this were to continue, its engine business could generate the £3bn of additional earnings needed to propel the group to the top of the FTSE 100 by the middle of the next decade. And this ignores any additional contribution from its other divisions.
However, there are no guarantees. The pandemic showed how the aviation industry can be vulnerable. And problems with the group’s engines – as experienced by Cathay Pacific Airways in 2024 — have the potential to impact earnings and dent confidence in the brand.
Over the next 10 years, I can see Rolls-Royce being worth much more than it is today. But the Footsie’s other larger businesses should also grow over this period.
Whether the group becomes the UK’s number one doesn’t really matter. As long as it continues to improve its bottom line – and I think there are plenty of reasons to suggest it will – its share price should keep rising. For this reason, investors could consider the stock.
