The Rolls-Royce (LSE:RR) share price has outperformed the FTSE 100 and the wider market by some distance over the past 18 months. It’s a turnaround story that’s worthy of all the attention it gets.
However, the Labour government, which swept to power in early June, presents new opportunities and potential obstacles for the British engineering giant.
So, let’s take a look at three ways Labour could impact Rolls-Royce.
Defence spending
Defence is Rolls-Royce’s second largest business segment and is responsible for around 25% of sales. Unsurprisingly, this is a part of the business that is performing rather well at the moment, with Russian hostilities and Chinese assertiveness leading to new Western commitments to defence spending.
Rolls-Royce doesn’t sell guns and ammunition but provides the propulsion for military vehicles. As such, it benefits from governments committing to long-term programmes, such as AUKUS and Tempest, more so than munitions resupply like some of its defence peers.
With regards to Labour, the government has committed to increasing the UK’s defence spending to 2.5%. While there is no timeframe for this yet, Labour says it will happen faster than it would have done under the Conservatives. This could be a boost for Rolls, but that’s yet to be seen.
Small modular reactors
Rolls-Royce is one of a handful of companies shortlisted to produce small modular reactors (SMRs). These nuclear reactors will be part of a wider effort to increase nuclear energy capacity to 24 GW by 2050.
It’s uncertain what approach the Labour Party will take to SMR, but Rolls-Royce does appear to be the frontrunner in the process.
Currently, SMRs fall under a business segment called New Markets, and the company has received some development grants — £18m — and could receive a further £215m in the second phase of the programme.
While a final investment decision is unlikely until the end of the decade, it could represent a major part of the business from the 2030s onwards, generating what I assume would be billions in instalment and servicing revenue.
Union troubles
Rolls-Royce is no stranger to union action. Far from it. The engineering giant has lost thousands of working hours to strikes already this year. Most recently, workers on its nuclear submarine programme went on strike for a month over the company’s failure to present an acceptable pay increase.
Labour has its roots in the union movements and comes to power on the promise to deliver a new deal for workers’ rights. This could push the balance of power back in favour of the unions, putting Rolls’s current pay structure and potentially profitability per worker, under pressure.
However, it’s obviously worth noting that more harmonious relations between unions and business would likely be welcomed, if this can be achieved.
The bottom line
Labour could present both challenges and opportunities for Rolls-Royce. However, it’s certainly worth noting that at 28 times forward earnings, some analysts will argue that it’s priced for perfection.
While I personally still think the stock is undervalued with its price-to-earnings-to-growth (PEG) ratio of 1.03, I accept that its stretched near-term metrics make it more vulnerable to surprises.
