The last 12 months have been terrific for the Rolls-Royce (LSE:RR.) share price. After being decimated by the 2020 pandemic, the group has undergone a radical internal transformation to narrowly avoid bankruptcy. And what’s emerged is a far leaner operation with lower debt and significantly higher profit margins. Therefore, it’s no surprise that the shares have climbed nearly 150% over the past year.
In fact, the stock is now only around 30p shy of returning to pre-pandemic levels. So, with the recovery almost complete, is it too late to invest in this FTSE 100 engineering giant?
What’s next?
Looking at the group’s latest half-year results, there are a lot of encouraging signs. For starters, net debt, which has long been a problem for this company, dropped from £3.3bn to £2.8bn. And a closer look at the loan book reveals management has restructured its borrowings to be almost entirely fixed rate. In other words, further interest rate hikes by the Bank of England won’t compromise the financial health of this enterprise.
Over on the profitability side of the equation, earnings per share came in at 14.7p versus a loss of 19.29p last year. And net cash flow from operating activities more than doubled.
There are a lot of factors behind these significant improvements. However, at the heart lies Rolls-Royce’s Civil Aerospace division. With long-haul travel finally ramping back up, demand for the group’s services is following suit, providing solid revenue growth. And with many fixed costs involved in manufacturing and maintaining plane engines, the division had an underlying operating margin of 9.7% compared to 2.4% in the first half of 2022.
Meanwhile, its Power Systems and Defence segments also saw improved performance as more cost efficiencies were introduced.
Pairing all this with the excitement surrounding the firm’s role in the revival of the UK’s nuclear energy sector, these shares look like they could have a bright future.
The bear case
As encouraging as these headlines are, there’s still a lot of work to be done. And the recent growth may not be as impressive as it seems on the surface.
For starters, a lot of the recent expansion stems from the recovery of its Civil Aerospace division. However, with the long-haul travel market nearing pre-pandemic levels, growth may be set to slow considerably. And with it, the recent share price momentum.
At the same time, there’s still £4.9bn of long-term loans to address. And fixed rate or not, that’s adding pressure to the bottom line. The reintroduction of free cash flow can provide the funding needed to minimise leverage. However, that also means there’s less funding available for research & development – a critical process for an engineering firm competing with the likes of BAE Systems and General Electric.
The bottom line
All things considered, the Rolls-Royce share price looks like it has tremendous potential in my eyes. However, I think there are still some important questions currently left unanswered. Personally, I want to see how the company performs once the recovery tailwinds stop blowing. Only then will investors know whether these shares are nearing their peak or if this recent growth is just the tip of the iceberg.
