Rolls-Royce (LSE:RR.) shares are the best-performing on the FTSE 100 in recent years. The stock’s rise has been driven by an incredible turnaround in the company’s financial performance.
In turn, this is thanks to an impressive cost-cutting drive and strong demand across all its main business units — civil aerospace, defence, and power systems.
Where does nuclear fit in?
Rolls-Royce has been developing small modular reactors (SMRs) that use nuclear fission to create energy on a relatively cost-efficient basis and with a greater degree of flexibility than their predecessors.
While this technology isn’t solely being developed by Rolls-Royce, it’s widely considered a world leader, with CEO Tufan Erginbilgiç repeatedly calling on the UK government to help protect its lead and commit to a future with SMRs.
However, this SMR development doesn’t fit into any of the above business units. It’s part of Rolls-Royce’s new ventures and it’s arguably the most promising programme in development.
Nuclear power’s the thing
Over the past two years there’s been a revolution in artificial intelligence (AI). AI workloads are extremely demanding and require substantial infrastructure to operate effectively. In particular, they rely heavily on power-intensive data centres. These require a significant proportion of global energy.
So with the Western world making some movement away from fossil fuels, and with renewable energy still somewhat unreliable, there’s been a renewed interest in nuclear energy. Private investment’s been soaring and governments are once again making nuclear a priority after a period in the dark.
And if you haven’t been following, nuclear stocks have surged. For example, Range Nuclear Renaissance ETF — an exchange-traded fund with nuclear holdings — has soared 92% over 12 months.
Investing in Rolls for a nuclear future
Nuclear energy isn’t a major part of most analysts’ investment thesis for Rolls-Royce. And I think that’s possibly wise given the time horizons for the engineering giant’s nuclear programme. It plans to have its first SMR operational in the UK in 2030, and despite being selected for SMR development in Czechia, the first one there won’t be operational until the early 2030s.
That’s not to say further catalysts with regards to Rolls-Royce nuclear programme won’t boost the share price. However, it may be the case that investors won’t be willing to assign value to a programme that won’t become cash flow positive this decade.
As such, for exposure to nuclear power, I’d suggest Rolls-Royce isn’t the best option. Instead, there’s a handful of interesting US-listed companies that are at the forefront of existing nuclear technology.
The bottom line
Rolls-Royce is a booming company, but that doesn’t mean there aren’t risks. An uptick in inflation could harm demand for air travel — engine flying hours represent a major proportion of revenues — while the pandemic suggested this business is vulnerable to demand shocks. Moreover, as a UK-based business, changes to employer National Insurance contributions could hurt earnings.
However, I’d suggest it’s hard to bet against this great business. All three segments are booming and the nuclear programme offers an additional opportunity for long-term growth. I keep changing my mind here, but with a substantial holding in Rolls-Royce, I probably won’t buy more despite its strong prospects and its discount versus its US peers.
