After rising 11% in the past month, Rolls-Royce (LSE:RR) shares are at a 52-week high and approaching 1,200p. And a 52-week high these days means all-time levels for the FTSE 100 engine maker, following a stunning 2,124% share price surge in just five years.
Ongoing progress
Unfortunately, I didn’t invest back in 2020. I only got involved in 2023, a few months after Tufan Erginbilgiç came in as CEO with some bold plans to transform the firm’s profitability.
As we now know, the turnaround’s been remarkable, and shows no sign of slowing. In H1, Rolls reported that underlying operating profit jumped 50% to £1.7bn, with the margin improving to 19.1% (from 14%).
Civil Aerospace led the charge with margins of nearly 25%, boosted by contract renegotiations and better time on wing for engines. Operating profit here jumped 63% to almost £1.2bn.
Power Systems enjoyed double-digit growth from data centre and government demand. Meanwhile, Defence orders totalled £4bn, swelling the backlog to £18.8bn (+120%).
Management raised full-year guidance to £3.1bn–£3.2bn of profit and £3bn–£3.1bn in free cash flow. The company has also completed £0.5bn of its £1bn share buyback. And an interim dividend of 4.5p per share was announced.
Why I’m invested
A key part of my investment thesis is that the company has strong growth opportunities across all of its divisions.
In Civil Aerospace, there’s the steady increase in long-haul international travel, driven by rising numbers of middle-class consumers across Asia. Defence should also prosper as military budgets remain elevated, including Europe’s massive project to increase its own industrial defence capabilities. And the Power Systems unit is benefitting from a splurge on data centres, fuelled by the rapid rise of power-hungry artificial intelligence (AI) systems.
Additionally, there’s the small modular reactor (SMR) business. This wasn’t much talked about when I invested in 2023, but my view remains it will become a significant growth driver for the company inside the next decade.
Reality is, nuclear will have to become a bigger part of the UK and Europe’s energy mix if fossil fuels are to be gradually phased out over time. According to various sources, the global SMR market could grow to $295bn by the 2040s.
So in my mind, the company offers exposure to four growth areas (international travel, defence spending, data centres/AI, and SMRs).
Competition
Now it’s worth pointing out that there’s lots of competition in SMRs. There are dozens of start-ups, including NuScale Power and Oklo. So there’s no guarantee Rolls will dominate this market. Moreover, the technology isn’t yet proven at scale, and there could be challenges that delay its deployment.
Having said that, I think many SMR start-ups will fail due to the capital intensity of the projects. But being selected as the sole provider in the UK, and the preferred provider in the Czech Republic, should give Rolls-Royce’s SMR a competitive advantage.
Buy more shares?
My takeaway here is that the long-term investment case remains strong. So I won’t be selling my shares.
But whether I would buy more comes down to valuation. Right now, the stock’s trading at around 42 times this year’s forecast earnings. That appears too pricey for me, so I’ll wait patiently for a pullback before I consider adding to my holding.
