Image source: Rolls-Royce Holdings plc
Rolls-Royce (LSE:RR.) shares have risen 170% since November 2023. Over this period, the stock has been the top performer on the FTSE 100.
In the past, whenever the stock of a particular company performed well, I had a tendency to think I’d missed the boat. I’ve often fallen into the trap of waiting, hoping that the share price will fall to give me another opportunity to buy the stock. But I’ve learned that day may never come.
Now I take more of a long-term view. If a company’s prospects are good and its shares are reasonably valued, I don’t think its ever too late to invest.
So how does Rolls-Royce measure up? To answer this, I think it’s necessary to consider its three operating divisions separately.
Up in the air
Civil Aerospace contributed 45% of its underlying revenue in 2022. Not surprisingly, the business was severely impacted by the pandemic and the devastation inflicted on the airline industry.
Rolls-Royce earns revenue for each hour that its engines are in the air. In 2022, its large engine flying hours were 10m. Five years earlier, they were 14.3m. But global air travel is now back to pre-Covid levels and, encouragingly, flying hours for the first six months of 2023 were 6.2m.
The company expects to deliver 400-500 engines in 2023 (against 190 in 2022). Although going in the right direction, it’s a long way short of the 753 delivered in 2013. That same year, its aerospace revenue was £969m/17% higher than it was in 2022.
It therefore appears to me that although the airline industry is now back to where it was in 2019, the company still has plenty of scope to further increases its earnings.
Air and sea
The company’s Defence division — which contributed 29% of revenue in 2022 — supplies engines for military aircraft and helps propel the UK’s nuclear submarines.
Ethical investors may not like the company’s exposure to this sector but the global market continues to grow.
According to the Stockholm International Peace Research Institute, global defence spending was $2.24trn in 2022, and has risen every year since 2015. NATO continues to urge its 31 members to spend 2% of national income on armed forces.
The growth prospects for this division appear good to me. At 31 December 2022, its order book was £8.5bn — equal to 2.3 times its annual revenue.
Full power
The company’s Power Systems division supplies on-site generation and propulsion solutions, contributing 26% of turnover in 2022.
It appears to be the weakest of the three, with the company increasing prices to try and reverse a falling margin. The impact of this on future orders is unclear.
Looking further ahead, the company’s well positioned to benefit from the development of small modular reactors. But these mini nuclear power stations aren’t expected to be ready before 2030.
Caution
Despite this positive outlook, there are a couple of issues that give me concern.
Although falling, debt is high relative to earnings.
And I don’t think its shares are in bargain territory. The company’s market cap is currently 14-16 times its expected operating profit for 2023.
However, on balance, I don’t think its too late to invest. And, if I had some spare cash, I’d take a position in the company.
