Rolls-Royce (LSE:RR) stock was charging higher in the FTSE 100 today (30 July). As I type, it’s up 6% after the engine maker knocked the ball out of the park (again) with its first-half results.
Heading into today’s print, investors were a bit cautious due to the Middle East conflict and volatility in the global supply chain. Could Rolls-Royce keep delivering the goods in such a challenging environment?
Well, the answer is an emphatic yes, and the stock is now up 1,370% in five years!
What did Rolls-Royce report?
Underlying operating profit in the first half jumped by 46% to £2.5bn, with higher profitability in all three divisions. That comfortably beat market expectations and was a noticeable jump from the £1.7bn reported in the same period the year before.
In its key Civil Aerospace business, the underlying operating margin improved to 25.3% (from 24.9%) as the firm benefitted from contract renegotiations and efficiency drives. A total of 254 large engines were ordered in the first six months, including sizeable contracts from Atlas Air, Delta Air Lines, SAS and LATAM Airlines.
CEO Tufan Erginbilgic commented: “In Civil Aerospace, where we continued to improve our aftermarket profitability, we have also effectively eliminated aircraft on ground, providing a significant operational benefit to our customers“.
In Defence, the operating margin increased to 21%, up from 15.4%. And here management said Rolls-Royce is “cementing” its position as a global leader in autonomous propulsion, a market with “significant growth potential“.
Note, the UK government just allocated £5bn of funding for autonomous defence systems, as the wars in Ukraine and the Middle East highlight how advanced they’ve become.
Finally, in the Power Systems division, the underlying operating margin also improved significantly, from 15.3% to 20.3%. Growth in this unit is being boosted by power generation demand from data centres, including use of the firm’s products as a primary power source rather than just backup.
What about full-year guidance?
The big news for shareholders came from upgraded full-year guidance. Previously, Rolls-Royce expected operating profit to be between £4bn and £4.2bn. Now, that figure is expected to be £4.7bn-£4.9bn.
For context, management only upgraded the mid-term (2028) guidance to £4.9bn-£5.2bn in February. So the company is on the verge of reaching that almost two years early!
Free cash flow guidance for the full year now stands at £3.8bn-£4bn, up from £3.6bn-£3.8bn previously. And longer term, the cash-generating potential looks very attractive due to long-haul engine upgrades that are expected to improve time on wing by more than 100%.
Caution still warranted
All in all, this was another cracking set of results. So why isn’t the stock surging even higher than it is today?
One issue is that the valuation already had lofty growth expectations baked in, with a forward earnings multiple of 33 before today’s results. So the bar was set high.
Plus, while large engine flying hours rose by 4% to 113% of 2019 levels, this was driven mainly by new aircraft deliveries. And management now expects full-year flying hours to be towards the lower end of its range of 115%-120%.
Therefore, with the Middle East conflict still raging, I think some caution is warranted from interested investors. I’m going to hold on tightly to my shares rather than buy any more.
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Ben McPoland owns shares in Rolls-Royce.
