Rolls-Royce (LSE: RR.) shares have been a phenomenon in the last 12 months. The UK engineering group has seen its market value soar 176% higher in the last year to £33.7bn, or 390p per share.
That’s an incredible rebound from one of Britain’s most iconic companies. To put it in perspective, the FTSE 100 has climbed 4.3% over that same period.
Some investors may be calling the top for Rolls-Royce shares given the recent gains. I’m more bullish on the British manufacturer in 2024 for a few reasons.
Money, money, money
Shares in the UK aerospace group charged higher after its February full-year earnings release.
Rolls-Royce posted a £1.6bn underlying profit in 2023 – more than 200% than its £652m effort in 2022. It also beat analyst expectations across all of its divisions.
This was music to investors’ ears, with the company’s shares soaring 8% on 22 February.
It’s not just the underlying profits that caught my eye.
Any value investor worth their salt will have heard that “cash is king”. The British group’s revitalised management team is focused on generating cash flow.
I wouldn’t expect Rolls-Royce to resume paying dividends until it has gained an ‘investment grade’ credit rating. Fitch Ratings has the company one notch below that at ‘BB+’ with a ‘Positive’ outlook.
However, I do like the pathway to dividends that I could see forming based on a strong operational foundation.
Executing its strategy
Another reason I like Rolls-Royce at its current 13.6x price-to-earnings (P/E) ratio is a clear strategy backed by good execution.
The company is going from strength to strength, and is capitalising on revenue opportunities while slashing costs. I think a doubling of its underlying operating margin from 5.1% in 2022 to 10.3% in 2023 shows that it’s working.
Monday’s Derby expansion announcement, increasing capacity to deliver over 40% more new engines per year from 2025, is just the latest example of its growth strategy in action.
Favourable macro environment
Rolls-Royce has a few divisions, spanning: civil aerospace; power system, and defense. This gives the company a few different levers for growth.
Things are more uncertain around the world than they have been for quite some time with rising tensions. Couple that with more than 40% of the world’s population being eligible to vote in 2024, and it’s a tense world at present.
Increased geopolitical risks have traditionally been associated with higher defence spending. Deglobalisation, meaning reduced international trade and collaboration, isn’t a reality just yet but remains a risk.
In my view, this creates higher potential spending on defence, and therefore opportunities for Rolls-Royce to deliver across critical areas like power systems, defence and aviation.
Weighing it all up
I’m wary of the risks to the share price as well.
It wasn’t so long ago that the company was under pressure to deliver these costs. A strong share price run has been good for investors, but also means a lot is riding on these current transformation and growth initiatives.
Reputation risk, supply chain disruptions and other unforeseen challenges could see investors take their profits and run for the hills.
I’m wary, but personally fairly bullish on the UK group’s share price right now.
