Given that they were selling for pennies little over a year ago, the current price of shares in Rolls-Royce (LSE: RR) is amazing.
The stock is around three times higher than at the start of last year. It is up around 600% since its 2020 lows.
If the shares went up another 600% from here, they would trade for over £20 each. But the current situation is very different to 2020 and so I think possible gains are different too.
What about a more-modest-but-still-big gain?
Say, for example, the 225% or so increase it would take to push Rolls-Royce shares up to £10?
Strategic delivery
One thing I think would be essential for that to happen is for the company to deliver on its strategic plan, if not exceed it.
The recent share price rise has been largely driven by the current chief executive setting out ambitious new plans for the company. They include aggressive financial targets. I think hitting those is important even for the shares to stay at their current level, let alone go higher.
But if those ambitious targets are hit, cynics about the firm’s ambition may be won over. That could push Rolls-Royce shares higher still.
Imagine if the company achieves its upper-end medium-term target of £2.8bn in annual operating profit. A £10 share price would then mean a price-to-operating profit number of around 9.
Earnings are affected by non-operating elements like finance and investing costs, so that is not a price-to-earnings ratio. Still, it does not sound unreasonably expensive to me if the targets are hit.
Business improvement
Not all of the increase has been due to the turnaround plan, however.
Some of it reflects the fact that, as weak pandemic-era travel demand moves further into the past, Rolls-Royce’s core business has improved.
Rolls has become profitable again. It is generating free cash flow. The balance sheet carries less debt than it did several years ago.
If we see further business improvements — for example a new engine range performing well — that could help Rolls-Royce shares.
I do not want to double count here, as some such improvements are clearly factored into the strategic plan. But with new engines in the pipeline and strong demand for defence hardware, the business looks set to benefit.
No demand shocks
However, there is only so much that is under the firm’s control.
Rolls has suffered in the past when there were sudden shocks in demand for civil aviation engine sales and servicing. The pandemic is just the most recent example.
Such a sudden drop in customer demand could cause big problems for the firm, hurting revenues and profits. If Rolls-Royce shares are to have any chance of hitting £10, I think there would need to be a complete absence of sudden plunges in demand.
Why I’m not buying
On balance, then, I think it is a long shot that the shares will hit £10 in coming years. But I do think it is possible.
That would be over double the previous all-time high. To have any chance of doing that, Rolls needs to deliver on its highly ambitious plans and possibly start hitting even bigger ones.
Yet the key element of demand is largely outside its control. That risk and the company’s patchy track record of performing consistently means I will not be buying the shares at the current price.
