Invezz.com - Rolls-Royce (LON:RR) share price has gotten supercharged, as investors bet that its recent momentum has more room to run. It has risen for four consecutive weeks, reaching an all-time high of 500p.
This recovery means that the stock is up by over 68% this year, beating the FTSE 100 index, which has risen by less than 10%, and BAE Systems (LON:BAES), which has risen by 16%. It has also jumped by over 1,200% from its lowest point in 2020.
Turnaround gathers momentum
Rolls-Royce Holdings is an important British company that does three primary businesses: civil aviation, defense, and power. In its aviation business, which accounts for over 50% of total revenue, the company sells engines to airlines and then enters into long service contracts with them.
Aircraft engine maintenance is a long and highly expensive process. Therefore, the company charges these airlines per flight hour, so that they can spread their costs over time.
The biggest risk for Rolls-Royce is if an engine develops issues as we saw with its popular Trent 1000 engine that started to develop cracks. As a result, aircrafts using the engine were grounded and the company spent a substantial amount of time and money in repairs, leading to over £1 billion in losses.
The company has solved the issue with the engine and committed to be more rigorous in R&D and in manufacturing.
It has also done other things to turn around its business. It sold its ITP Aero business in a 1.7 billion euro deal during the pandemic. Exiting this business gave it the cash it needed to stay afloat as airlines grounded their planes.
The company also made painful job cuts and brought in a new CEO, Tufan Erginbilgic, who has worked to simplify the company and make it more profitable.
As part of his turnaround strategy, he has scaled down some of his predecessor’s ambitious projects like the focus on hydrogen engines. He has also pledged to focus on partnerships to gain access to the popular narrow-body plane industry instead of developing a new program from scratch. Most importantly, he has introduced new profit ambitions for the company.
Rolls-Royce restarts its dividend
Rolls-Royce Holding’s investors have endured a lengthy period of no cash returns because of its significant challenges.
Now, the company has reinstated its dividends, starting at 30% of its underlying profit after tax. It hopes to keep the payout ratio between 30% and 40% in the long term.
The most recent results showed that the management’s strategy was working as its first-half revenue rose to £8.18 billion from £6.95 billion in the same period in 2023. Operating profit almost doubled to £1.14 billion while its profit before tax jumped to £1.035 billion.
Rolls-Royce has also worked to boost its balance sheet as its net debt came in at £0.8 billion by repaying £550 million. It also canceled the remaining £1 billion UKEF0suppoted undrawn loan facility.
Most notably, the company has enough funds to handle next year’s maturities of £1 billion and the £1.6 billion lease liabilities.
Rolls-Royce has other potential catalysts. While its big aircraft engines bring in the most cash, the company is now ramping up deliveries for its Pearl 700 engine for the Gulfstream G700 business jet that went into production in April. The management hopes to deliver 40% more Pearl engines from 2025 vs 2023
Rolls-Royce hopes that its investments in engine quality and efficiency will draw more aircraft in its ecosystem in the next few years.
Additionally, the company has also become an underappreciated player in the artificial intelligence industry. It is doing this because of its large power business, which has seen robust demand, helped by backup power for data centers. Its power systems revenue rose by 6% in the first half of the year to over £1.87 billion.
Altogether, Rolls-Royce has continued doing well and the management is confident that the trend will continue. A key issue, however, is that the company seems a bit overvalued, with a forward P/E ratio of 34, higher than the industry average of 22.50.
Rolls-Royce share price analysis
The weekly chart shows that the Rolls-Royce stock price has been in a strong bull run in the past few years. It has jumped from a low of 34.95p in 2020 to about 500p today. Most recently, the stock has flipped the crucial resistance point at 442.9p (January high) into a support level.
The stock has held steady above the 50-week and 100-week moving averages while the Relative Strength Index (RSI) has moved to the overbought point. Also, the MACD indicator has remained above the neutral point.
Therefore, based on trend-following principles, there is a likelihood that the stock will continue rising as buyers target the key target at 550p. The alternative scenario is where it drops and retests the support at 442p.
This article first appeared on Invezz.com
