Rolls-Royce (LSE:RR) shares are up 158% over five years. That doesn’t tell the whole story because the stock slumped during the pandemic and has since risen 1,500% from its lows. It’s an incredible story and quite frankly, an investor would need ultra strong conviction to remain invested throughout. Nonetheless, a £10,000 investment five years ago would now be worth £25,800. However, at one point, that £10,000 investment would have been worth just £1,300. It’s the type of volatility most of us aren’t used to seeing on the FTSE 100.
A fresh start
Rolls-Royce has dramatically transformed since the pre-pandemic era through strategic restructuring. The company executed a comprehensive financial overhaul, raising £2bn through asset sales and workforce reductions. Digital transformation accelerated, with initiatives like the Digital Academy enhancing technological capabilities.
Supply chain improvements and operational efficiency became critical focus areas. The company strategically repositioned itself, emphasizing financial resilience and sustainable performance. Leadership changes drove a more agile approach to market challenges.
While core aerospace and power systems businesses remain unchanged, Rolls-Royce emerged leaner and more adaptable. By 2024, the company returned to positive free cash flow and reintroduced dividends, signalling a successful post-pandemic recovery strategy. The fundamental engineering DNA remains, but with a more modern, flexible execution model.
Catalysts galore
Rolls-Royce’s aviation recovery has been a defining catalyst in its post-pandemic transformation. Civil aerospace flying hours have rebounded and engine deliveries are rising, particularly in long-haul jet production for Airbus, driving significant profit growth. Strategic investments in engine research and development have focused on improving durability and efficiency across challenging global conditions.
Most recently, Rolls-Royce secured a landmark £9bn nuclear contract with the UK Ministry of Defence, further diversifying its strategic portfolio and reinforcing its technological leadership. This builds on a host of recent announcements, several around its high potential small modular reactor business.
There must be some risks
However, like any investment there are risks. The cyclical aerospace industry leaves it vulnerable to economic downturns and travel demand fluctuations. Geopolitical tensions, supply chain disruptions, and emerging technologies like electric aircraft pose threats. High R&D costs, lengthy development cycles, and stringent regulations in aviation and nuclear sectors present ongoing challenges. Meanwhile, currency fluctuations add further complexity to its global operations.
Valuation still favourable
Rolls-Royce’s valuation may appear high for a FTSE 100 company, but its price tag is potentially justified. With a forward price-to-earnings (P/E) of 33.2 times, it’s 66.3% above the global industrials sector median. However, this is 21.2% lower than its five-year average, indicating improved value. Crucially, Rolls-Royce’s forward price-to-earnings-to-growth (PEG) ratio of 1.15 is 37.4% below the sector median, suggesting better value relative to growth prospects.
Rolls-Royce appears cheaper than its peer GE Aerospace, which trades at 37 times forward earnings with a PEG of 2.1. The sector has exceptionally high barriers to entry, requiring substantial upfront capital and advanced technological capabilities. This competitive moat, combined with Rolls-Royce’s strong market position in widebody aircraft engines and sole-source contracts, supports its valuation premium. The company’s improving profitability and growth prospects further justify its current price levels.
If my holding wasn’t already large compared to the size of my portfolio, I’d buy more. It’s worth consideration by other investors.
