Rolls-Royce (LSE: RR) shares have thrashed the FTSE 100 lately, and I can see a number of reasons why they may continue to outperform.
1. Rolls-Royce is on a roll.
After a decade of disaster — including a bribery scandal, repeated profit warnings and the pandemic lockdown — the rot seems to have stopped. Rolls-Royce shares have more than doubled in the last six months, and continued to climb despite the recent FTSE 100 dip.
2. It’s making money again.
Revenue jumped from £11.2bn to £13.52bn in 2022, while statutory operating profit climbed from £513m to £837m. There’s still a long way to go, but this comes as much-needed relief after the decade of disaster.
3. The world is flying again.
Rolls-Royce generates its biggest revenues from the servicing contracts that accompany its aircraft engine sales, which are based on miles flown. That backfired during the pandemic, as flying hours collapsed.
Now we’re back in the air, with large engine flying hours back to 65% of pre-pandemic levels last year, and heading towards 90% in 2023, boosted by China’s post-Covid reopening. Let’s just hope we don’t get a major recession and people stop travelling again!
4. New boss means business.
New CEO Tufan Erginbilgic made a splash with his first public statement, calling current performance “unsustainable”. Now the oil industry veteran is under pressure to live up to his tough talk, which should keep him and the company focused. Unless he’s all mouth, of course…
5. The world is in a warlike mood.
Wouldn’t it be wonderful if world peace broke out? Until it does, we will need weapons. Rolls-Royce is a leading engine maker for the military transport market with 16,000 in service, and 160 customers in more than 100 countries. Plus its nuclear reactors will power a new fleet of Australian submarines.
6. It’s opening up a new front.
Management is placing big hopes in its small modular reactors, we should allow it to build many nuclear plants. Finland and Sweden are interested. The UK is, too, despite the usual dithering. This could open up a whole new revenue stream.
7. The dividend will return.
Rolls-Royce axed its dividend in 2020, and there’s been no shareholder payments since then as the company focuses on repairing its balance sheet. Yet last year it became free cash flow positive again, bringing in £500m after losing £1.5bn in 2021.
While I don’t expect a dividend this year, it could be back in 2024 or 2025. It may not be much at first, but it will be a baby step in the right direction.
Of course, there are risks to buying Rolls-Royce shares. While its key Civil Aerospace division is back to profitability, losses recently widened in the New Markets division.
Management still has to shrink its £3.3bn net debt and the balance sheet needs a lot more work. Plus there’s a recession in sight, and the oil price has been rising as OPEC cuts output. Rolls-Royce also takes a long time to generate a return on capital invested.
The rocketing share price adds risk, as it may consolidate for a while. But I reckon the long term looks a lot brighter for Rolls-Royce than it has done in years. I already hold shares in the company, but I’d like to buy more!
