Rolls-Royce (LSE:RR) shares have performed perhaps the greatest turnaround in FTSE 100 history. The speed of the recovery has been breathtaking to behold.

In January 2023, when CEO Tufan Erginbilgiç officially took the helm, the share price was 99p. Fast-forward 43 months to today, it’s now around 1,500p.

Putting that into context, it would have turned a £3,000 investment into approximately £45,000. Assuming, of course, that an investor held on to every share along the way, which is easier said than done.

A key lesson

For me, Rolls-Royce provides an important lesson. It’s that a capable management team with the right plan can make a massive difference if the ingredients are present for a turnaround.

I’m not talking about every new CEO or all businesses. If a firm doesn’t have a compelling product offering or strong brand, or operates in an industry where barriers to entry are low, even the best CEOs might struggle to make a difference.

In the case of Rolls-Royce though, it already had a massive installed base of engines. And the barriers to entry in the aerospace industry are enormous, both from a technical/engineering and regulatory perspective.

As for the plans, most turnaround CEOs turn up and announce cost-cutting and restructuring. Rolls-Royce had done that over the years without creating much lasting value for shareholders.

What attracted me to the stock in 2023 was that Erginbilgiç was intent on transforming its culture, as well as making it more financially resilient to survive outside shocks like another pandemic.

There’s a big difference between restructuring and transformation. Transformation, to my mind, is more ambitious. It’s taking the company from point A to point B, where getting to point B opens more potential for the company.
Tufan Erginbilgiç.

A key resilience metric

Admittedly, calling the firm a “burning platform” when he arrived could have backfired. Rolls-Royce has world-class talent and such comments could have alienated top engineers.

But the chief executive has indeed made the company far more resilient. For me, the most dramatic change is seen in the total cash cost to gross margin (TCC/GM) ratio, a new key performance indicator management introduced to the aerospace industry.

What is this? It’s basically a measure of the business’s underlying cash costs relative to its gross profit. A lower number is preferable.

In 2019, before the pandemic, this figure was 0.9. This basically means that if there was a 11% hit to gross margin, the company was in the red. To improve this, management tackled costs from “multiple angles“, with the aim of getting it down to 0.4.

At the end of June, the TCC/GM ratio came in at just 0.27. This best-in-class ratio makes the company significantly more profitable and, crucially, resilient.

Erginbilgiç rightly calls this structural margin of safety a “competitive advantage“.

Premium valuation

Given this, I think Rolls-Royce deserves to trade at a premium valuation. Right now, that means a forward earnings multiple of around 32.

However, if the engine maker’s growth disappoints, the valuation could quickly come under pressure. So, despite my long-term optimism as a shareholder, this probably isn’t the time to consider loading up.  

But for long-term investors who are willing to think about building a position on dips, Rolls-Royce shares could still be worth investigating further.  

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Ben McPoland owns shares in Rolls-Royce.