Rolls-Royce revs its engine
The group has benefited from the bounce back in air travel and offers value
One of the biggest recent turnaround stories on the stockmarket is Rolls-Royce Holdings (LSE: RR). Although it was struggling for several years before the pandemic, Covid-induced travel restrictions caused demand for the engines that were the mainstay of its business to collapse. Forced to issue a large chunk of new shares to stay afloat, the group saw its share price fall by 80% in the first nine months of 2020. While the stock rallied in 2021 on hopes that the end of travel restrictions would bolster demand, as late as last February it was still selling for less than half its pre-Covid level.
However, since then the shares have been on a tear. They are now roughly 70% higher than they were in January 2020 and close to levels not reached in the last decade. This is partly because the cuts in investment by airlines during Covid created a shortage of aeroplanes, leading to a boom in sales. However, another key reason is the group’s CEO, Tufan Erginbilgic. He has restored discipline when it comes to costs, reducing waste and ensuring that the company doesn’t take on projects that will lose money, one of Rolls-Royce’s traditional weaknesses.
Tackling debt
As a result, RollsRoyce is finally making enough cash to pay down debt, resulting in the recent upgrading of its bonds. However, it’s not just a case of trimming fat or focusing on more profitable areas of the aircraft business. Erginbilgic has other ambitious plans that should enable Rolls-Royce to keep growing in the long run. These include the development of small modular reactors (SMRs). These SMRs get around one of the chief problems with nuclear power, which is the need to invest large sums of money upfront in huge plants. By contrast, SMRs can be built more quickly and cheaply. This should make it easier to scale up the amount of nuclear power produced in the UK, something that most experts agree is crucial to achieving net-zero carbon emissions without imposing massive costs on industry and consumers. While Rolls-Royce isn’t the only company working on SMRs, experts think that its advanced technology puts it ahead of the pack.
Overall, Erginbilgic thinks that a combination of further efficiency gains, improvements to the firm’s jet engines and the development of SMRs could boost Rolls-Royce’s profits fourfold over the next five years. While this is certainly ambitious, consider that operating margins more than doubled between 2021 and 2023, while revenues soared by 45% in the same period. Viewed in this context, the fact that Rolls-Royce trades at 22 times 2025 earnings seems more than reasonable.
Rolls-Royce’s share price, meanwhile, has momentum behind it. It is trading well above its 50- and 200-day moving averages, it’s making new 52-week highs, and has gained almost a quarter in the last month alone. I’d therefore go long at the current price of 390p at £7 per 1p, and put the stop-loss at 250p, which gives you a total downside of £980.
“CEO Tufan Erginbilgic thinks that profits could quadruple over the next five years”