Rolls-Royce (LSE: RR) shares recently powered above 500p after the engine maker’s H1 results. This record high has some investors worried that the FTSE 100 high-flier has gotten ahead of itself.
That may be true in the near term, with the stock trading at around 30 times forward earnings. But that didn’t stop me buying more shares in my ISA recently at 477p. Here are four reasons why I did.
Firing on all cylinders
First off, I was very impressed with the company’s H1 results. It was hard not to be. Revenue increased 19% year on year to £8.2bn, with growth across all three core divisions. Operating profit jumped 74% to £1.1bn, with the margin increasing 4.4% to 14%. Free cash flow more than tripled to £1.2bn.
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Meanwhile, net debt is now down to £822m, the lowest in more than five years. This has been recognised by the credit rating agencies, with two out of three now rating the company as investment grade.
Looking ahead, the firm expects 2024 underlying operating profit of £2.1bn-£2.3bn, up from its previous guidance of £1.7bn-£2bn. It also expects free cash flow of £2.1bn-£2.2bn rather than £1.7bn-£1.9bn.
The dividend’s back
Second, the dividend’s been reinstated after more than five years. The firm will start by paying out 30% of underlying post-tax profit before an ongoing payout ratio of 30-40% each year.
Granted, the prospective dividend yield for 2025 is puny, at just 1.2%. But I’m hoping the payout will grow nicely over time given the incredible free cash flow improvement.
Stepping back, this reinstatement’s symbolic given the financial crisis Rolls faced during the pandemic. The rapid turnaround under CEO Tufan Erginbilgiç has been astonishing.
Higher price target
Next, the consensus share price target from analysts is currently 542p. That’s still around 8.8% higher than the current level.
Naturally, this price target isn’t guaranteed and there are risks. One is that multiple international airlines are suspending flights as Middle East tensions rise. If the conflict escalates, this could lead to reduced demand for new aircraft and engines. Severe supply chain issues also persist across the industry.
The future looks bright
In the long term though, the investment case still looks strong to me. Over the next 20 years the number of aircraft is expected to double, according to Boeing and Airbus. This will be driven mainly by China and India, where Rolls-Royce is positioning itself to seize the vast opportunities arising from this growth.
Then there are small modular reactors (SMRs), those mini versions of a nuclear power plant. These are no longer the stuff of science fiction. The UK government could be soon be dishing out a contract and Rolls-Royce could be at the front of the queue.
Sweden and the Czech Republic have been doing due diligence on Rolls’ SMR technology and I’m sure they won’t be the last. After all, those decarbonisation target dates enshrined in law are looming ever closer.
Understandably, this potential isn’t reflected in the share price today. But I’m investing here with a minimum five-year view, so I’m hoping it will be one day.
Each SMR will cost around £2bn-£2.5bn, so this could be a truly enormous new growth market for Rolls-Royce by the early 2030s.
