The Rolls-Royce (LSE: RR) share price was the FTSE 100 investment story of 2023. It skyrocketed almost 225%, nearly doubled its nearest competitor Marks & Spencer Group, while almost matching US chipmaker Nvidia‘s stellar performance.
Newsflash. There’s no way that’s going to happen in 2024. Any investor approaching this stock must accept they have missed the early fun. They must put all thoughts of making a quick fortune out of their heads. Things will get stickier from here.
This year will be different
‘New broom’ CEO Tufan Erginbilgiç had made an immediate splash by slamming his new charge as a “burning platform” and after the initial shock, investors loved it. It’s a trick he can’t repeat though. Other forces will drive performance now.
Rolls-Royce shares were down around 75% when he took over (they trade just 10.1% higher than five years ago). Expectations were rock bottom. Investors were thrilled to discover that one man reckoned he could make Rolls-Royce fly again, and he happened to be the man in charge. After the tough love, now that man has to deliver.
Erginbilgiç is aiming high with his plan to transform the company and quadruple profits in the next four years. Much of his early efforts are straight out of the recovery playbook, such as dispensing with 11,500 jobs to drive “efficiency, simplification and synergies”. The same goes for his plan to exit fringe operations and focus on the group’s “core electrical engineering activities” in Power Systems, Defence, and Civil Aerospace.
Rolls-Royce is now aiming for an operating profit of between £2.5bn and £2.8bn by 2027, with operating margins of around 13-15%. Given that the group made a pre-tax loss of £1.5bn in 2002, that’s pretty ambitious stuff. Yet there’s a huge opportunity here to transform the company’s fortunes and build a real global player. It isn’t hard to see why investors are getting excited.
He won’t have it all his own way
Yet I’m not convinced by Erginbilgiç’s publicly-stated plan to negotiate hard with suppliers, which invites push back. It has already sparked a public row with Dubai-headquartered airline Emirates, which told Rolls to improve the durability of its products first.
Thai Airways has also switched business away from Rolls due to pricing issues with CEO Chai Eamsiri warning: “If you play hard, you may win in the short term but lose in the long term.” Sounds ominous to me.
Investors must beware that black swan events like war, pandemic or volcanoes could hit flying hours, and income engine maintenance contracts. Rolls is particularly vulnerable, given the high hopes built into its share price, which now trades at 152.72 times earnings. That said, the forecast valuation is a more modest 37.2 times.
I still think Rolls-Royce is on the verge of brighter times, and Erginbilgiç could rebuild its reputation as a Great British engineering company. Debt was once a huge worry. But it will fall to £2.3bn in 2023. In 2024, it could plunge to just £698m. The dividend will return this financial year. By 2024 it will yield just 0.58%, but should climb over time.
Yet after the excitement of 2022, investors need to cool down a little. The stock has come a long way in just one year but may be due a bit of retrenchment, in my view.
