Rolls-Royce shares soared by over 20% last week after reporting a huge jump in profits. The news caught many investors off-guard, but is it too late to climb aboard now?
At first glance, I don’t think it’s too late at all. This was an absolutely cracking trading update, in my opinion. But let’s take a closer look.
Four magic words
The aerospace engineer reported significantly improved profits and cash flow in the first half of the year. It noted that results for the second half are expected to be “materially above consensus expectations”.
I often watch for these four magic words as a signal to take note.
Its multi-year transformation programme seems to be working well. And combined with a recovery in long-haul flying, results have greatly improved.
It now expects operating profits for the full year of £1.2bn-£1.4bn. Taking the top end of the range, that’s a whopping 50% ahead of market consensus.
That’s why I suspect Rolls-Royce shares have further to climb.
Making progress
Rolls-Royce CEO, Tufan Erginbilgic, only took over at the start of the year. He was tasked with raising profits. And it looks like he’s making excellent progress, so far.
Rolls-Royce earns much of its sales from servicing its engines, so it benefits when more planes are flying. As travel restrictions during the pandemic caused severe disruption to aviation, it makes sense to look at how things are going compared to 2019.
That gives a clearer picture of how the business is recovering. With that in mind, it’s encouraging to see that engine flying hours now stands at 83% of 2019 levels.
Travel restrictions around the world continue to ease, so I expect this figure to improve by the end of the year.
Points to note
With so many encouraging points, what could go wrong? Well, the Rolls-Royce share price has doubled so far this year, and it currently sits at the top of the FTSE 100 leaderboard. It could be argued that it’s all in the price now and any further gains could be limited.
Also, the global economy is still battling high inflation in many parts of the world. Soaring interest rates could put pressure on household budgets. In turn, it could result in a drop in air travel, particularly for leisure.
I’m usually not keen on capital intensive companies with high debt. Last year, Rolls-Royce had around £3.3bn of net debt, which remains uncomfortably high.
Investors should keep an eye on how well it continues to manage these borrowings.
Final thoughts
Overall, despite much progress being made, I feel that Erginbilgic has more work to do. That said, I’m impressed with how things are going.
This is a resilient and growing business. And I’m looking forward to seeing more progress in the multi-year transformation programme.
If current trends continue, I feel my optimism will increase. Looking ahead in the coming year or two, I suspect today’s share price might even feel like a bargain. That’s why I’ll be adding these to my Stocks and Shares ISA as soon as I have available funds.
