Rolls-Royce shares surge again on stunning results

The “burning platform” which the current Rolls-Royce Holdings (LSE:RR.) CEO inherited three years ago has been transformed into a business which is now, quite simply, on fire.

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The turnaround has been achieved due to a number of factors and, with existing targets being consistently blown away, the group has upgraded to a new set of stretching aims, with the current strength of the business seen as a milestone rather than a destination.

Quite apart from its exposure to military defence products, which has lately come into sharp focus, the group’s Civil Aerospace unit which accounts for over half of group revenue is paid on flying hours for its engines. This increased by a further 8% over the year with an expected 115% to 120% of pre-pandemic levels now in plain sight, when those payments unsurprisingly ground to a halt. 

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The Rolls-Royce transformation has also included optimisation and cost efficiencies, where £600 million of savings since 2022 has exceeded the previous £500 million target. Net cash, which stood at £475 million last year (and net debt of £1.95 billion the previous year) now stands at £1.9 billion as the group continues its relentless cash generation. 

Such strength previously enabled the reintroduction of the dividend, where a projected yield of 0.8% is less important at this stage than the statement of management confidence which it displays. Indeed, any lingering doubts on the group’s ambitions have been further put to rest with the announcement of an additional £2.5 billion share buyback, which should lend further support to the shares. Nor does the financial largesse stop there, with the new buyback programme being part of an aim to return between £7 billion and £9 billion over the next three years.

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All of this was achieved despite the constraints of supply chain issues for key components which have blighted the entire sector and any indirect tariff implications. Indeed, the numbers are stunning across the board. Revenues grew by 12% to £20.06 billion, ahead of the expected £19.6 billion, while underlying pre-tax profit spiked by 46% to £3.35 billion, ahead of the estimated £3.2 billion. Operating margin grew from 13.8% to 17.3%, propelled by margins of 20.5% in Civil Aerospace (previously 16.6%), 14.4% in Defence (14.2%) and 17.4% in Power Systems (13.1%).

A Return on Capital of 18.9% compared to 13.8% in the corresponding period, while free cash flow jumped from £2.43 billion to £3.27 billion to complete the set. Such is the strength of the numbers that new stretching targets have been set, far outpacing the previous guidance. 

For the coming year, the group now projects underlying operating profit of between £4 billion and £4.2 billion and free cash flow in a range between £3.6 billion and £3.8 billion. Out to 2028, these translate to operating profit of between £4.9 billion and £5.2 billion and free cash flow of £5 billion to £5.3 billion, in addition to which there are new targets for operating margin (18% to 20%) and Return on Capital (23% to 26%).

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Of course, with punchier valuations come higher expectations and more pressure to keep growing earnings to stay in line. However, there is nothing in this sparkling set of results which casts any immediate doubt either on the group’s current ability to deliver, nor indeed its outlook over the coming years.

The immediate reaction to the results is unsurprisingly and rightfully positive, adding to this extraordinary corporate turnaround which has resulted in a share price gain of 863% since the CEO’s appointment three years ago. In the last year alone, the price has risen by 113%, as compared to a spike of 24% for the wider FTSE100, and the group clearly has unfulfilled ambitions to maintain the momentum. In the meantime, investor appetite for the stock remains undiminished and the market consensus of the shares as buy will almost certainly remain intact.