Despite being on the verge of bankruptcy a few years ago, Rolls-Royce (LSE:RR.) shares have made a spectacular comeback. The engineering giant is now back on the list of most bought UK shares, according to Hargreaves Lansdown. And a quick glance at the stock price chart immediately says why.
The stock is up almost 170% in the last 12 months. That means If I’d bought £1,000 of Rolls-Royce stock in March 2023, my investment would have almost tripled landing at £2,700. Considering the FTSE 100 has only grown by around 6% over the same period, including dividends, the company’s performance is undeniably impressive. But the question now becomes, will this upward trajectory continue? Let’s explore.
Transforming fortunes
Since CEO Tufan Erginbilgic moved into the corner office, he’s been deploying some radical changes to the firm’s corporate structure and business model. In the early days, the jury was out on whether this course of action could save the company from oblivion. Today, I think it’s fair to say he was right.
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The group’s 2023 full-year results saw operating profits and free cash flow surge to levels not seen in years. And it’s helped tackle one of Rolls-Royce’s biggest problems – leverage. Net debt is now down to £2bn versus £5.2bn at the end of 2021.
Of course, this transformation hasn’t been painless. Thousands of workers unfortunately lost their jobs. And another 2,500 positions appear to still be on the chopping block as Erginbilgic continues to explore cost-cutting opportunities.
Overall, the firm has delivered £150m of annualised savings versus its target of at least £400m that was set out last year. And when paired with the expected return to growth of the travel market this year, the stock could still deliver further upward momentum in the near term.
Taking a step back
With the business seemingly firing on all cylinders, its Nvidia-like returns are quite understandable, especially considering it was starting from such a low base. However, it’s possible that investors may have gotten ahead of themselves.
On a forward basis, the price-to-earnings (P/E) ratio sits at a whopping 30. That’s almost double the industry average. And it seems investors have priced in the group’s ability to deliver on its milestones significantly ahead of time. Providing that Rolls-Royce continues to impress, such a lofty valuation would be justified. However, an unexpected hiccup would likely translate into some significant volatility. And it’s possible one’s already on the horizon.
With the recovery tailwinds of the travel industry on the verge of evaporating, investors will soon see how much of Rolls-Royce’s stellar performance stemmed from internal action rather than external factors. And if it’s the latter, the shares could be in for a reality check. Therefore, I’m keeping this enterprise on my watchlist for now.
