The Rolls-Royce Holdings (LSE:RR.) share price performance over the past five years has been remarkable.
Those who followed Warren Buffett’s advice in the early days of the pandemic – “Be fearful when others are greedy and be greedy when others are fearful” – have been handsomely rewarded. Since March 2020, its share price has risen six-fold.
The group’s market cap received another boost in February, when the company reported its 2024 results
These revealed an underlying operating profit of £2.46bn, earnings per share (EPS) of 20.29p, and free cash flow of £2.43bn. This helped propel the share price above £7 for the first time. And it has continued to rise since.
But, in my opinion, this meteoric increase means its shares aren’t cheap.
Based on a current (31 March) price of around £7.50, the group trades on a historic earnings multiple of 37. This puts it on a par with some members of the ‘Magnificent Seven’ which, on paper at least, makes it hugely expensive.
Looking forward
However, it’s the future that counts. And encouragingly, the directors were positive about the group’s prospects. On results day, they said: “Our upgraded mid-term targets include underlying operating profit of £3.6bn-£3.9bn and free cash flow of £4.2bn-£4.5bn. These mid-term targets are a milestone, not a destination…”.
Although ‘mid-term’ isn’t defined above, it’s been confirmed to mean 2028.
Even at the lower end of the range quoted, if the anticipated increase in operating profit of 46% is translated into an identical improvement in EPS, the group’s share price could hit £10.96 within four years. At the top end, it would be £11.88.
If that isn’t enough to get shareholders excited, the directors also see “strong growth prospects beyond the mid-term“. Much of this is expected to from its civil aerospace and defence divisions.
According to the International Air Transport Association, the world’s airlines will be carrying another 4.1bn passengers by 2043. More flights mean additional engine flying hours, a key driver of profit.
Also, an increasingly unstable world is likely to lead to more military spending. The European Union recently announced plans to spend an additional €800bn on defence. The propulsion solutions developed by Rolls-Royce are used across the globe but, to date, Europe remains a relatively untapped market. This could soon change.
Looking further ahead, I think the group’s development of small modular reactors (factory-built mini nuclear power stations) could be highly lucrative.
Pros and cons
But the group faces some challenges. It’s difficult to continually innovate and come up with new solutions.
And in 2024, the share price wobbled when Cathay Pacific had to cancel some flights over fears of engine component failure.
Also, its dividend isn’t particularly generous. At the moment, the group’s shares are yielding 0.8%. But as long as the share price continues to rise, investors are likely to ignore this.
Despite these risks, I see no reason why the Rolls-Royce share price couldn’t reach £11 (or more) over the next few years. The group’s post-pandemic recovery reflects well on the management team. And it demonstrates how a company with a strong brand and a reputation for engineering excellence can survive even the most difficult of circumstances.
On balance, I think it’s a stock that investors could consider adding to their portfolios.
