Image source: Rolls-Royce plc
It has been a wild ride for shareholders in Rolls-Royce (LSE: RR) over the past few years. After hitting pennies at points during the pandemic, the Rolls-Royce share price has certainly bounced back lately.
It has risen 176% so far in 2023, an incredible jump for a FTSE 100 share. That still puts it just 1% up over the past five years, though.
Can the run keep going – and ought I to invest?
Big ambitions
Since a new chief executive took the helm this year, we have seen a stream of big announcements from the company. The prospect that a leaner outfit with a sharper focus on finance could see profits surge helps explain why the Rolls-Royce share price has been on fire.
The latest boost to the shares came this week when the company updated the City on its plans and targets. They are very ambitious.
Management plans to make the firm “financially stronger and more resilient than it has been before”. Specifically, it has medium-term targets of £2.5bn–£2.8bn of annual operating profits, annual free cash flows of £2.8bn–£3.1bn and a return on capital of 16%–18%.
Hitting those targets could be a tough task.
Last year’s underlying operating profit was £652m and underlying free cash flow was £505m. Last year was not a banner year for Rolls, but it was a better performance than we had seen in the previous few years. So the new targets envisage improving some of the company’s key financial metrics by a factor of four or five.
Putting the plan into action
The business has still been getting into its stride following a massive slowdown in civil aviation demand during the pandemic. That alone could help results improve in coming years.
It also announced this week that it plans to continue selling off parts of the business in the coming five years. That could let it focus capital and effort where there is the most potential reward.
With a large entrenched customer base, a pipeline of new engine technology, and limited competition, I think the business has the wind in its sails. I do expect business performance to keep improving.
There are risks, though.
A sudden demand in downturn for civil aviation could wreak havoc with Rolls-Royce’s financial performance again. I also reckon that the prospect of large operating profits could lead customers to drive a harder bargain for new engines, potentially making it difficult to boost profit margins substantially.
Further share price growth?
At the moment, the Rolls-Royce share price implies a price-to-earnings ratio of 15.
I do not see that as cheap but it is not unusually expensive for a blue-chip share, either.
Although operating profits and earnings are not the same thing, if the business hits the financial targets it laid out this week I expect earnings will also increase dramatically. That could drive the shares up.
Another 45% gain would see the shares hit £4 each. If the business proves next year that it is off to a flying start in hitting its goals, I could see that price being achieved next year.
That is a big ‘if’, however.
The company has spent decades struggling with inconsistent financial performance and demand swings. The risk of a sudden demand downturn outside the business’s control is a key reason I do not plan to buy the shares.
