Rolls-Royce (LSE:RR.) shares continue to defy expectations. After years of mismanagement and loading up on debt, the engineering giant’s foundations started wobbling before the pandemic came along and outright broke them. It wasn’t until a radical restructuring and changing of the guard did things start to improve.
With growth and free cash flow returning for the first time in years, investor sentiment surged, sending the stock flying. And this momentum has continued throughout this year.
More encouraging results surrounding cash flow generation and, most importantly, debt reduction have helped Rolls-Royce climb another 51%. Therefore, if I’d bought £1,000 worth of shares at the start of 2024, I’d now be sitting on a nice lump sum of £1,510.
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But will this upward trajectory continue? Or is now the time to start taking some profit. Let’s take a closer look.
The challenges that lie ahead
The risk of bankruptcy for this business is no longer a primary concern. After all, the group’s net debt position has drastically improved over the last 12 months. At the same time, there aren’t any major upcoming loan maturities that could compromise the business providing operations continue to deliver their improved performance.
However, that’s where questions begin to form. The majority of Rolls-Royce’s stellar comeback stems from the performance of its Aerospace division. With long-haul international travel almost completely returning to pre-pandemic levels, demand for the firm’s engine maintenance services has similarly increased.
But market recoveries tend to provide powerful short-term boosts before growth starts to slow. As such, there’s a good chance the company’s impressive surge in revenue and operating profits may not be a repeat performance moving into 2025. And with still another £5.8bn of debt and equivalents on the balance sheet, reducing leverage may take longer than currently anticipated.
Catalysts for growth
Recovery tailwinds may be coming to an end. But Rolls-Royce shares could end up replacing them with several other growth opportunities. The most obvious is the eventual cutting of interest rates. Apart from making its debt more manageable, it could also spark a new wave of customer orders.
Don’t forget, aircraft engines aren’t cheap, costing up to around £30m depending on the model. But as access to capital becomes easier, airlines may be looking to upgrade their fleets. The timing is also quite exciting since the company’s latest and most powerful UltraFan engine is expected to be launched in 2025.
Meanwhile, its other business segments also seem to be making good progress. Increased international conflict, while tragic, is good news for the demand from its Defence segment. While the Energy division prepares its mini-nuclear reactor technology for launch in 2029.
The bottom line
All things considered, the long-term picture for this enterprise looks encouraging. However, there’s still a fair amount of uncertainty for the near-term growth potential. If I held the stock, the recent stellar growth would warrant a partial sale depending on the size of the position within my portfolio. But for those happy to hold on for the next decade, Rolls-Royce shares seem like they have a promising future under its new leadership.
