Rolls-Royce Off 70% YTD Highs

Airlines have been showing remarkable recovery, with some brushing off concerns about a recession, supporting Rolls Royce's engine division. Are any clouds on the horizon?

Airlines Add to Optimism

Analysts are highly optimistic about Rolls Royce as the global airline industry rebounds and aircraft engine demand rises. Only 2 out of 17 analysts have a negative rating for the company, and the consensus is for another jump in profitability in the current quarter. Airlines are notoriously bullish about their prospects for the rest of the year, such as United's CEO dismissing concern about a pending recession. Long-haul air travel is recovering as China resumes international commercial flights after a nearly three-year hiatus.

Airlines are also buying up record numbers of jets as the pandemic is over, including hundreds of new long-haul, wide-body aircraft. Rolls Royce's Trent engines hold a dominant position in the long-haul space, which could support growth for the company over the coming years. Most recently, the company affirmed its guidance in this sector, seeing recovery in civil aviation returning to the 80-90% of pre-covid activity range.

It's Not Just Jet Engines

While sales in civil aviation have been doing good, the company's segment has an operating margin of just 2.5%. It does represent nearly half of the company's revenue. The second largest segment is defence, with an almost five times higher operating margin at almost 12%. The war in Ukraine has increased demand for defence spending worldwide, and the UK has vowed to increase the supply of more sophisticated weapons systems. For now, the UK MoD is supplying out of existing inventory, but at some point, that will presumably have to be replaced, which could give Rolls Royce another boost.

The company's latest trending update on the annual meeting disappointed analysts a bit in simply reaffirming guidance instead of affirming the more optimistic view by raising the outlook as some had expected. The new CEO, Tufan Erginbilgic, seems to be more cautiously approaching the company's outlook. Better to underguide and overperform than overguide and miss expectations if the feared recession does materialise.

RR Appears in Consolidation Phase

Rolls Royce soared as high as 70% YTD in March but slowed to around 60% near 150 GBX recently. The spike to 160 broke a multiyear range above 150 GBX, but prices falling below the said barrier have opened room for bearish speculation.