With the Rolls-Royce (LSE:RR.) share price surging almost 90% in the last 12 months, the engineering giant has reached a record-high valuation of £68bn. That’s over 800% higher than just a few years ago, demonstrating the rapid improvements new CEO Tufan Erginbilgiç has delivered across the company. And now, with European defence spending on the rise, a new kindly tailwind is blowing for Rolls-Royce.
So can the engineering giant continue to surge?
The power of exceeding expectations
Analyst consensus for 2024 is that revenue’s expected to reach £17.35bn, and earnings per share will land at 18.18p. Following the group’s latest results, investors were understandably pleased that the company smashed forecasts, with sales landing at £17.85bn and earnings at 20.17p per share.
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Exceeding earnings expectations by double digits is no easy feat. Yet continued operational efficiencies helped deliver better-than-expected margin expansion. Subsequently, underlying operating profits surged from £1.59bn to £2.46bn, while free cash flow essentially doubled from £1.29bn to £2.43bn. And best of all, that tipped Rolls-Royce’s balance sheet into a net cash position of £475m.
Yet looking at management’s guidance for 2025, this momentum doesn’t seem to be stopping. Free cash flow‘s anticipated to reach as high as £2.9bn by the end of this year, with underlying operating profits coming in at a similar level.
What’s more, the group’s 2028 mid-term targets also got upgraded, with free cash flow on track to reach anywhere between £4.2bn and £4.5bn, with underlying operating margins rising from the current 13.5% to as high as 17%. Pairing all this with a surprise £1bn share buyback announcement, it’s no mystery why the Rolls-Royce share price has been on a rampage.
But what does this all mean for investors hopping on board now?
Where’s Rolls-Royce headed?
As thrilling as the stock’s performance has been, it’s important not to get too caught up in the excitement. On a forward price-to-earnings basis, the shares are currently trading at 34 times the projected profits for 2025. That’s certainly not cheap. And it suggests investors have already baked in the firm’s revised 2028 earnings targets.
This is likely why, when looking at analyst forecasts, the average consensus reveals a 12-month price target of just 807.5p. That’s a 1% projected gain from current valuations.
Of course, management’s developed a habit of beating expectations. So if it continues to deliver better-than-expected results, more double-digit returns could be just around the corner. However, should the company stumble, then with so much future growth already baked into the share price, shareholders may have to endure some downward volatility.
One potential cause of this would be supply chain disruptions. Like many aerospace businesses, Rolls-Royce relies on just-in-time logistics. And with geopolitical tensions high in Eastern Europe, supply chain disruptions may start to emerge if the situation escalates. Alternatively, should conditions start to calm, defence spending promises across Europe may fail to materialise, hampering a growth catalyst for the business.
As a business, I believe Rolls-Royce has delivered a pretty remarkable turnaround thanks to prudent leadership. But as a stock, the valuation’s a bit too rich for my tastes right now. Instead, I’m looking at other companies in this sector that are far more reasonably priced.
