Just like the 12 months that preceded it, 2024 was a vintage year for Rolls-Royce (LSE: RR). While Rolls-Royce shares were not the best performer in the FTSE 100 index, as they had been the prior year, they were still on rip-roaring form.
Over the past year, the aeronautical engineer’s share price has soared 94%.
Looking over five years, the company’s pandemic-era existential crisis now seems a long time ago. Rolls now stands 165% higher than it did at this time in January 2020. That was before the pandemic started to make the City nervous.
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So, having almost doubled over the past year, could the Rolls-Royce share price do the same again in the coming 12 months? Or might it halve, taking it back close to where it stood a year ago?
The doubling scenario
At first glance, the prospect of the share doubling seems far-fetched. After all, this is a mature company in a mature industry that has already soared over the past couple of years. I, for one, would be surprised to see this happen in the coming year, although that does mean it cannot.
However, there is a case to be made for this scenario.
The current price-to-earnings (P/E) ratio is 22. That does not strike me as cheap. Then again, it is substantially cheaper than other engine makers such as New York-listed peers GE Aerospace (sitting at 33) or Pratt and Whitney owner RTX (36).
Part of that disparity can be explained by the generally lower valuations in the London market currently, compared to US peers. Still, Rolls could move up substantially (though not double) without being more expensive on a price-to-earnings basis than key rivals.
There is another possible lever for a big leg up in the Rolls-Royce share price and that is improved earnings.
In that case, even maintaining today’s P/E ratio, let alone a higher one, would imply a higher price. Both basic and underlying earnings per share showed a marked jump in 2023 compared to the prior year.
Last year’s annual results should come out next month. They will include details on how the engineer is progressing against its ambitious medium-term financial targets.
If the company delivers strong further improvements in earnings, I think that could help propel the shares higher.
The halving scenario
I doubt those results will disappoint significantly, or we would likely have had a profit warning before now.
But one thing that could send the share price down is if the company signals that it looks unlikely to meet its self-imposed targets over the next several years. It has been an inconsistent performer for decades, so I do see that as a credible risk.
One challenge of trying to boost earnings is that, after the initial cost cuts (themselves posing reputational risks in a safety-critical industry), pushing up selling prices can lead customers to shop around more.
A key risk that I think could lead to the shares halving is a sudden external shock that leads to a dramatic slowdown in civil aviation demand. This is why I will not invest at today’s price.
The pandemic was an example, but such a shock could also be a volcanic eruption grounding flights, or terrorist attack.
