- Rolls Royce announced revenue and profit growth of 14% and 48% respectively
- Shares rocketed 20% on better-than-expected results
- Engineering company completes a long-term base pattern and set for a turnaround
Rolls Royce is an illustrious name in the UK industry. Once famous for making the most extravagant car in the world, the company has pivoted into aerospace and defence. Most recently, the company is seeking to pioneer modular nuclear reactors – a smaller but more efficient version of the older reactors.
While it is a household name, has Rolls Royce provided good shareholder returns for investors? A quick glance at its long-term chart suggests not.
In 2022, Rolls Royce share price collapsed from 130p to 65p – fall of 50 percent. At its low, Rolls Royce’s share prices were only a little higher than the level registered back in the nineties.
Moreover, the past two years saw extreme stress on the company’s revenue and profitability. The massive multi-billion rights issue 2020 diluted existing shareholders and the firm then restructured its workforce by sacking 9,000 workers. All in all, it was a titanic struggle for the aerospace company during the pandemic.
However, it appears that the worst is over for the company.
Earlier, I talked about the case for buying Rolls Royce due to: a) Fading pandemic and increased air travels, b) reasonably strong balance sheet (due to the rights issue), c) a move into the nuclear sector and d) depressed share price.
Indeed. Following the latest annual results it seems that investors are re-rating the stock as revenue and profits rose by more than expected. This suggests that the stock was suppressed by overly bearish outlook earlier. Prices surged this week to 130p.
What’s next for the engineering firm? Having cleared the psychological 100p level, it appears RR’s near-term momentum is bullish and may lead to further gains for shareholders.
Therefore, there is a case for buying Rolls Royce for the long term. But the recent rally has eroded future returns somewhat for new buyers.
Normally, we would say, buy them when they are down.
Last year, Rolls Royce shares tanked as investors sold out of major UK shares. As recently as August, Rolls Royce was looking rather shaky at 60p. A little more selling would have broken that floor. In all, RR’s shares have fallen nearly 80 percent from the peak in 2018 (at 360p).
But the decline in 2022 was the last down phase of a 5-year downtrend. Rolls Royce’s share price has been down for so long that buyers have either ran out of money or patience.
The recent rally from 70p to 130p – a gain of 85% – suggests that a bull phase is potentially starting. Most sellers are either out. Those that remained are staying for the long haul.
Therefore, a retracement back to double-digit share price may be used for long-term accumulation.
Like most of the other stocks, it is extremely hard to put a valuation on a company these days – as share prices can change by 25% in a week to render these figures outdated.
While Roll Royce’s profitability has improved in 2022, the company is not out of the woods yet. Yes, it has a huge billion order book, inflation and rising cost base are two negative factors in Rolls Royce business that may dent its future profitability. The company also carries a £3.2 billion debt pile, not a good burden to bear when interest rates are rising.
The good thing is that RR is generating ample cash flow. No longer are investors fearing another dilution down the road as RR now has £500 million of free cash flow.
At £9 billion market cap, Rolls Royce is neither cheap nor expensive. I suspect its shares will continue to range trade at 100-150p for the time being.
Source: Rolls Royce plc.
The last few weeks have brought a huge respite for Roll Royce’s long-suffering shareholders. Price rallied from mid-sixties to near 130p at the time of writing – a gain of more than 80%. The advance was propelled by:
- A rally in the global stock market – that brought about a rebound in most stocks including Rolls Royce
- Recovering aerospace/airline stocks – which led to a bounce in Roll Royce’s share price (EasyJet bottomed out at roughly the same time as Rolls Royce)
- Better-than-expected earnings – which saw the market re-rate the stock immediately from 107p to 130p.
The breakout at 100p led to further buying momentum.
However, the stock is now tilting into short-term overbought. So while RR’s short-term momentum is favourable I would not rule out a general market correction some time in the next few weeks as investors re-assess the inflation outlook.
To be fair, the brokerage community is hardly enthusiastic about Rolls Royce.
This is supported by the fact that nearly half of the broker panel is recommending a‘Hold’, which can sometimes translated into ‘avoid’. Four put out ‘Sell’ recommendations outright.
We can see why. With share prices still languishing way below its 2013 peak of 430p, investors who held over this period are hugely underwater. Therefore, until Rolls Royce share price start to recover we expect analysts to continue their conservative prices estimates.
The median price forecast is 110p. At 130p, the market is already shooting past these forecasts. Either brokers have to raise their predictions or investors will start selling. I suspect both.