The Rolls-Royce (LSE:RR) share price had a terrific 2023, climbing by over 200%. This made it the standout performer among FTSE 100 companies.
Now you might expect that after such a run, it would experience a more modest return this year. However, modest seems to be a word that is alien to its shares.
Fast-forward six months and they’ve already skyrocketed by 55%. This easily trounces the Footsie, which has gone up by a more ‘modest’ 7%.
If we stretch back our time horizon to October 2022, Rolls-Royce shares were trading for the lowly price of 70p. At the time of writing on 5 July, it’s 461p, representing a 563% return.
Imagine being a shareholder of the company during that run! If I’d invested £10k back then, I’d have £56,300 today. But I’m not going to think too much about this missed opportunity. Rather, as a forward-looking investor, I want to predict where the share price will rest at the end of the year.
The bull case
Under its current CEO, Tufan Erginbilgiç, who took the helm in early 2023, Rolls-Royce has staged an impressive comeback.
If we look at full-year results for 2023, both the top and bottom lines grew at a strong pace. Revenue went up from £12.7bn to £15.4bn. Profit after tax also accelerated by 620% from £158m to £1.142bn.
Seeing a business improve its operating margins shows us that management is running it well. So, this increase from 5.1% to 10.3% is good to see.
Another point to note is that its net debt fell from £3.3bn to £2bn by the end of 2023.
The company is also guiding for strong growth over the medium term (based on 2027 timeframes). What excites me is how the operating margin is expected to improve further to 13%-15%. The civil aerospace division, the company’s largest revenue source, is expected to be operating with a margin of 15%-17%. This is also the fastest-growing division, so it’s nice to see it will also be the most profitable.
The bear case
The above looks nice and well, but it’s not so simple.
Firstly, Rolls-Royce shares are quite expensive. Its price-to-earnings (P/E) ratio of 30 is over double the average of the Footsie.
Secondly, its greatest strength can also be considered its greatest vulnerability. Its civil aviation engine sales are heavily dependent on the wider economy, which is outside of the firm’s control. If finances for individuals become strained, then they may be less likely to take a holiday. Or if another pandemic occurs, travel will be restricted. These scenarios can hamper the demand for flying.
Thirdly, after such a run-up in its share price, those who have invested in the stock for a while may take some profit off the table. This could create downward pressure on its share price.
Verdict
Overall, I believe Rolls-Royce shares are already priced for perfection. I don’t think the share price will go up much higher by the end of the year and I can see it hovering around the 460p mark.
However, that doesn’t take away from the fact that it’s still a great company. If I were to look at a longer time horizon than the next six months, I’d consider buying its shares because of the strong growth it’s exhibiting.
