In 2023, Rolls-Royce (LSE: RR) was the best performing share in the FTSE 100 index. Last year, despite having already risen sharply, the company was again among the index’s top performers. In under two months this year, the share price has moved up 24% by early trading today (27 February) following the release of Rolls-Royce’s annual results.
So, should I add some Rolls-Royce shares to my portfolio now hoping for another blockbuster performance from the engineering company?
Solid business helped by a favourable environment
The past is not necessarily an indication of what to expect in future, of course.
Despite the Rolls-Royce share price soaring 688% since the end of 2022, it still trades on a price-to-earnings (P/E) ratio of 27.
That is not cheap, but it does not sound wildly overpriced to me either. After all, Rolls-Royce is a fast-growing yet proven business, with a large installed base of engines, unique technology and trusted brand.
Meanwhile, the business areas in which it operates are very favourable ones right now.
British and European defence spending is set to surge in coming years. Civil aviation has had a very strong couple of years and many airlines have been expanding their fleets. This means that the demand not only for new engine sales but also engine servicing has boomed.
Rolls has been making hay while the sun shines
That has helped propel Rolls’ commercial performance.
In its results, the company reported revenue growth of 15% year on- year. Net cash flow from operating activities surged 94%.
The company firmly put its heavy indebtedness of the pandemic era in the historical dustbin, reporting a net cash position of £0.5bn. Compared to net debt of £2.0bn a year beforehand, that is excellent.
And it declared a dividend of 6p per share.
What about profits?
Here, things get a bit more complicated. What the company calls (and has long called) its underlying pre-tax profit rose from £1.3bn to £2.3bn. However, the statutory profit before tax (which is the one I prefer to use, for consistency of comparisons) fell from £2.4bn to £2.2bn. That was slightly disappointing in my view.
Rolls-Royce has now set even higher targets
So, why did the Rolls-Royce share price soar following the release of the results?
The surging share performance in the past few years has been a combination of business results coming in strongly and the company setting aggressive growth targets.
There was more of that today. The company said that this year it expects to deliver £2.7bn-£2.9bn of underlying operating profit and £2.7bn-£2.9bn in free cash flow. That is two years earlier than previously expected.
It also boosted its medium-term (2028) targets to £3.6bn-£3.9bn of underlying operating profit, 15%-17% operating profit margin, £4.2bn-£4.5bn free cash flow and 18%-21% return on capital.
The share price might keep going
Today has already seen the Rolls-Royce share price hit an all-time high.
I think it might rise even from here. The business performance is strong, demand is strong and the company’s aggressive goals should focus employee minds.
However, demand largely sits outside Rolls’ control. The risk of a sudden plummet in civil aviation demand due to a pandemic, natural disaster or terrorism puts me off buying. At its current P/E ratio, I do not see sufficient margin in the share price so will not be buying Rolls-Royce for my ISA.
