The Rolls-Royce (LSE:RR.) share price was a trailblazer last year, advancing by a stunning 221%. No other FTSE 100 stock came close to matching the iconic aerospace and defence business.
But, after a stellar run of gains, can the company repeat its stunning performance this year? Or should investors limit their expectations regarding what Rolls-Royce shares can potentially deliver in 2024?
Here’s my take.
The FTSE 100’s standout performer
Under CEO Tufan Erginbilgiç’s leadership, Rolls-Royce has undergone a dramatic transformation. The former BP executive has been brutal in his assessment of the company’s shortcomings, but the share price recovery tells a story of a business that’s well on the road to recovery.
Streamlining the company’s operations is a central goal for the relatively new boss. Boardroom shakeups, substantial headcount reductions, and ambitious financial targets have all become hallmarks of Erginbilgiç’s strategy in his year at the helm.
Beyond the market’s positive reception to Erginbilgiç’s approach, macro conditions have also improved significantly.
Long-term service agreements for civil aircraft are the lifeblood of the firm’s revenues. In that regard, a strong recovery in post-pandemic air travel has undoubtedly been a major factor in the stock’s rebound.
Nonetheless, Rolls-Royce shares still trade well below where they were before Covid-19’s arrival. Many long-term shareholders are still nursing heavy losses.
Reasons to be optimistic
In support of the investment case, several City analysts are increasingly bullish on the company’s near-term prospects.
Various investment banks now attach price targets over 400p to the Rolls-Royce share price, which implies a 26% upside or more from today’s level. Although broker forecasts aren’t gospel, they can provide useful insights on a firm’s growth potential.
The potential resumption of dividend payments and anticipated return to an investment-grade credit rating could be key catalysts in spurring further stock market gains. Movement on this front is positive, marked by S&P Global’s upgrade of Rolls-Royce’s rating to BB+ in December.
Long-term factors could also continue to sustain the stock’s positive momentum this year. After all, it’s often said that the market is forward-looking.
Indeed, the International Air Transport Association expects that air travel demand will double by 2040, elevated geopolitical uncertainty bodes well for the company’s defence arm, and the global transition to net zero remains an important tailwind for the power systems division.
Reasons to be cautious
Despite good reasons for optimism, there are notable risks facing Rolls-Royce shares too.
First, the stock has become more expensive after last year’s stunning rally. Currently, the company trades at a forward price-to-earnings (P/E) ratio higher than 29.3. That’s well above the average across FTSE 100 stocks and suggests much of the firm’s future growth potential may already be priced in.
In addition, a net debt pile of £2.8bn is also a concern. Although the company has made good progress in reducing its liabilities, it’s not out of the woods yet. Making further reductions while preserving service quality won’t be an easy task.
What I’m doing
Overall, I remain optimistic on Rolls-Royce’s prospects for 2024 and I’ll continue to hold my existing shares.
I think the stock merits serious consideration from investors, but a rich valuation suggests they might be wise to expect less spectacular growth than last year.
