2023 has been a terrific year for Rolls-Royce (LSE:RR.) shares. After being decimated during the pandemic, the engineering giant has more than doubled over the last eight months.
And with demand across the aerospace, defence, and energy sectors rising, this upward momentum looks poised to continue. So can investors expect more triple-digit gains from this company? Let’s explore.
Why are the shares on fire?
With most revenue stemming from commercial aircraft engines and their maintenance, global travel bans in 2020 created massive problems. So seeing this stock jump off a cliff was hardly surprising. Even less so, considering the huge debt on the balance sheet.
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Skip ahead to today, and the long-haul travel market has almost entirely recovered, non-core operations have been disposed to pay down debts, and a new CEO is in the corner office. The volatility of Rolls-Royce shares during this period reflects the ongoing internal restructuring that, unfortunately, saw thousands of employees lose their jobs.
However, there’s no denying Rolls-Royce is now in a far superior position than even before the pandemic. With revenues recovering and profit margins expanding, operating income for the first six months of 2023 came in at £797m. That’s a significant improvement from the £223m reported last year and the £713m loss in 2019.
Free cash flow is back in the black, pushing net debt to £2.85bn versus £3.25bn in 2022. And with the UK government eager to deploy the firm’s small modular nuclear reactors (SMRs) as a clean energy solution, a new source of long-term growth is developing.
Needless to say, this is terrific progress. And with new CEO Tufan Erginbilgic currently boasting a 76% approval rating from employees, according to Glassdoor, it seems most workers are also happy with the results.
In my experience, seeing double-digit growth, expanding profitability, new market penetrations with happy employees, and strong leadership is a recipe for chunky long-term gains. And while it may take several years, Rolls-Royce shares seem to have the potential to double again, in my opinion. But there are plenty of things that could get in the way of this.
Not out of the woods yet
Despite the cracks in the balance sheet being sealed up, lots of work remains to be done. As of June, £5.6bn of loans and lease liabilities remain on the books. While the bulk of these have fixed interest rates, the cost of servicing these loans is still significant. And if cash flow suddenly takes a turn for the worse, the impact on the bottom line could be significantly higher.
The solid double-digit growth across its Civil Aerospace, Defence, and Power Systems divisions is encouraging. However, it largely stems from recovery trends rather than new business. And with the rollout of SMRs around a decade away, growth could slow significantly once the recovery is complete. In other words, investors could be waiting a long time to see their money double if it happens at all.
All things considered, my opinion of this firm has improved significantly over the last two years. Rolls-Royce shares certainly have the potential to climb considerably higher if it can continue its impressive results. However, plenty of questions still need to be addressed.
For now, an investment still feels like speculation. Therefore, despite the potential, I’m keeping it on my watchlist for now.
