A lot of the conversation about the Rolls-Royce (LSE:RR) share price in recent months has been based around valuation. More specifically, some are starting to think that the stock is overvalued, given the 99% rally in the past year to levels not seen in over a decade. Despite this, I think some investors have missed one key growing area, which could give a further injection of life to the stock in the future.
Going nuclear
I’m talking about the rise of nuclear energy usage. The sector is rapidly emerging as the leader in the global energy transformation, with cleaner sources being demanded more. A big part of this is coming from the tech space. AI processors and models need an incredible amount of power. In the past few months, major companies such as Amazon and Microsoft have signed power purchase agreements, with many more likely to follow suit.
Given that I view AI adoption and usage as still in its early stages, the scope of nuclear power demand could grow significantly from here in coming years. Now let’s tie this view to Rolls-Royce. The business is at the forefront of developing Small Modular Reactors (SMRs). These are an innovative and cost-effective solution for nuclear power generation.
As countries move to adopt SMRs for power generation, Rolls-Royce could capture significant market share. Further, it’s worth noting that the company has already secured government funding for some nuclear projects. Over time, I’d expect more investment from the public sector, which could further help to boost overall revenue from this division.
Show me the money
Investors might like the sound of things so far, but there’s a big consideration not yet spoken about. Namely, what financial benefit could this area contribute to the overall business?
This is where things get a bit tricky. The public company owns Rolls-Royce SMR Limited and has the majority stake in it. However, the half-year results stated that “planned cost increases in SMR to meet development milestones resulted in an increased operating loss of £91m versus £78m in the prior period.”
Put another way, this area is still under development and is currently loss-making. I can’t find any information as to when it expects to flip to posting a profit, or even revenue projections. The full-year results are due out in just over a month, when I expect more information will be given. This should also include more detailed commentary on the outlook going forward for nuclear.
Share price implications
Investors might see the lack of financial results for nuclear so far as a risk right now. I accept this, but stocks can often trade based on future expectations, not just past results. Therefore, I think there’s potential for the share price to rally over the coming year based on increased awareness of nuclear as a theme and the foundations that Rolls-Royce has in this area. In fact, I wouldn’t be surprised if the stock got a major boost from excitement about nuclear power.
I’m going to wait and see what gets revealed in the annual results and make a decision from there.
