Rolls-Royce (LON: RR) share price continued its strong parabolic move this week, soaring to a record high of 530p. It has risen in the past four consecutive days, bringing the 12-month gains to 140% and the year-to-date surge to almost 80%.
This performance makes it one of the best-performing industrial stocks. Safran, a key rival, has risen by about 35% this year, while BAE Systems has jumped by less than 20%.
However, Rolls-Royce has continued to underperform GE Aerospace, whose stock has jumped by almost 90% this year.
Positive macro environment
Rolls-Royce Holdings has done well because of the strong performance of its three core industries.
The civil aviation sector is booming, thanks to the ongoing demand for business and leisure travel. In a recent note, IATA said that airline net profits will jump to over $30.5 billion this year, while the net profit margin will reach 3.1%.
Rolls-Royce is a major player in the civil aviation industry, providing some of the best engines and then servicing them in long-term contracts. Some of the most notable clients are companies like British Airways, Singapore Airlines, Emirates, Qatar Airways, and Delta.
The best indicator of Rolls-Royce’s business performance is the number of flight hours by its clients. In their recent earnings statements, most of these firms said that they were flying at capacity even as the summer season slowed.
RR is also a big player in the defense industry, where it offers engines for fighter aircraft, submarines, and military ships. It also develops solutions for land-based defense capabilities, including Mobile Tactical Power Units (TPUs), Vehicle Auxiliary Power Units (APUs), and Networks and microgrids.
This division has also done well in the past few years as countries have boosted their defense spending as geopolitical issues rose. The war in Ukraine is going on while Israel is trying to provoke a war in the Middle East.
Rolls-Royce Holdings’ power business is doing well as demand for power generation and marine energy rises.
Tufan Erginbilgiç is boosting efficienc
The Rolls-Royce share price has also surged because of Tufan Erginbilgiç, the Chief Executive Officer (CEO) who started working in January last year.
In his tenure, the company has unveiled an ambition to become a more profitable entity in the long term.
To do that, he has engineered between 2,000 and 2,500 layoffs. That is in addition to the 9,000 jobs it shed in 2020 as the Covid-19 pandemic hurt its business.
As part of his strategy, Erginbilgiç, a former BP executive, hopes that its annual operating profit will be between £2.5 billion and £2.8 billion in 2027 as its operating margin rises to between 13% and 15%. It also expects that its free cash flow will be between £2.8 billion and £3.1 billion.
Some analysts believe that, like General Electric, Rolls-Royce would be a better company if it split into three businesses. However, in his strategy presentation last year, Erginbilgiç maintained that he planned to maintain the three divisions.
Instead of separating the business, his goal is to ensure that the separate divisions work with the most efficiency.
The most recent results showed that the company’s revenue rose from £6.95 billion in the first half of 2023 to £8.18 billion this year. Its operating profit rose to over £1.14 billion, meaning that the firm will likely hit its target before schedule.
Rolls-Royce Holdings’ operating margin improved to 14% while its free cash flow stood at over £1.15 billion.
Most importantly, the company will now start to pay dividends with an initial payout ratio of 30%. This payout is expected to increase to 40% in the long term.
A key concern about Rolls-Royce is its valuation, which stands at £44 billion or $60 billion, making it one of the most valuable brands in the UK. This valuation means that it is trading at a price-to-target operating profit ratio of 15.
Data by SeekingAlpha shows that it has a forward P/E ratio of 36 and a trailing multiple of 20. While these are expensive figures, they are lower than General Electric’s 42 and 51.
Rolls-Royce share price analysis
RR chart by TradingView
Turning to the weekly chart, we see that the RR stock price formed a golden cross pattern in September 2023 as the 200-week and 50-week moving averages crossed each other. This is a highly popular pattern, which explains why it has surged hard in the past few months.
The risk, however, is that the stock has started to form a bearish divergence. As shown above, the Relative Strength Index (RSI) has started moving downwards, falling from this year’s high of 93 to the current 72.
Also, the MACD indicator has also retreated. Therefore, while the stock has more upside, there is a risk that it will have a pullback in the next few weeks.
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