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Rolls-Royce (LSE: RR) shares are the wonder of the age. Or at least, the last five years of it. The stock’s rocketed an astonishing 1,077% in that time. Those who timed it perfectly will be sitting on life-changing gains. Even latecomers have enjoyed a strong run, with the share price up 112% in the past 12 months.
FTSE 100 rocket
The pandemic almost broke Rolls-Royce. International travel froze, airlines mothballed planes and the FTSE 100 aircraft engine maker haemorrhaged cash. Former boss Warren East started the fightback but the real fireworks began when Tufan Erginbilgiç took over in January 2023.
Erginbilgiç began with a bang, slamming his new charge as a “burning platform”. That smacked of theatre, but he backed it up with action. He imposed financial discipline, streamlined operations and restored margins. His combative style isn’t without risks, as he’s clashed with airline customers, yet the results are hard to dispute.
Results drive fresh momentum
Latest half-year numbers released on 31 July gave Rolls-Royce yet another lift. Underlying revenues climbed 13% to £9.06bn, while group operating profit surged 50% to £1.73bn. Operating margins widened from 14% to 19.1%, while free cash flow jumped to £1.58bn.
Erginbilgiç said the multi-year transformation was delivering despite supply chain and tariff challenges. Investors lapped it up. So did brokers.
On 11 August, Citi multiplied its price target from 641p to 1,100p, saying cash generation and its 23% profit growth forecast justified the valuation. It also flagged up the potential value from small modular nuclear reactors.
Valuation’s stretched
With a market-cap of £87bn, Rolls-Royce is now the fifth-largest company in the FTSE 100. The price-to-earnings ratio’s above 52, making the stock expensive. If the shares doubled again within a year, Rolls-Royce would be the UK’s biggest. That’s surely too much to ask, even for ‘Turbo Tufan’.
Expectations are dizzyingly high. Rolls-Royce now forecasts underlying operating profit of £3.1bn-£3.2bn, up from £2.7bn-£2.9bn. Any shortfall will be punished. In fact, coming in on target may also been viewed as a fail. Those mini-nukes are a fantastic opportunity, but they’re not without order and execution risks. Any slowdown in flying as the US economy slows could hit aircraft engine revenues.
Broker forecasts suggest there’s more to come though. Just a week ago, consensus targets pointed to 1,157p. A rush of new upgrades has since pushed the 12-month average target to 1,213.5p. That implies a further 16.1% gain from today’s 1,045p.
Dividends and growth
Throw in the forecast yield of 0.7% and the total return could hit 16.8%. That would turn a £10,000 investment into £11,680. Nice, but hardly life-changing. For those just getting started, Rolls-Royce looks a very different beast from just a few years ago.
The higher the climb, the thinner the air becomes. I think investors could still consider buying, but only with the acceptance that the explosive phase of the recovery has already happened. At today’s price, I see a mix of growth potential, income promise and risk. I’m not selling my own shares though. I’m holding on for the long-term ride.
