Rolls-Royce's Profitability Doubles, But Can The Stock Keep Going?

British engine maker Rolls-Royce saw its profit double year-on-year thanks to increased sales for the rebounding airline industry.

A Remarkable Turnaround

One year ago, Rolls-Royce CEO Tufan Erginbilgic described the company as facing challenges, noting underperformance against "every key competitor." Since then, the firm has achieved a notable turnaround. Its share price rocketed 227%, while operating profits rose 144% for 2023. Moreover, the annual report revealed operating margin more than doubled, and EPS grew substantially to £13.75 from £1.95. However, Rolls-Royce is not yet returning capital to shareholders as it focuses on strengthening its balance sheet. Nonetheless, the results show strong progress toward the company's goal of quadrupling profits by 2028.

Rolls-Royce expects the positive momentum to continue, forecasting further operating profit growth to £1.7-2 billion in 2024, up from £1.6 billion reported last year. Of potential interest to investors hoping to see dividends or share buybacks eventually, free cash flow is anticipated to increase to a similar level from an even lower base. The company has reduced its net debt to £2 billion, indicating that management could soon feel comfortable restarting payouts to shareholders.​

Growth or a Temporary Rebound?

The company reported strong growth driven primarily by a recovery in demand from airlines seeking to meet rising passenger demand, combined with significant cost reductions through job cuts amounting to approximately 2500 roles. Management is striving to transform the business into a higher margin operation, taking a firmer stance on pricing with customers. While this strategy appears successful so far, at least one client - Thai Airways - disagreed with the approach and opted to transfer its business elsewhere.

Investors welcomed the results, pushing the company's share price up 8% following the earnings release. However, Rolls-Royce is not funnelling many funds to debt repayment as it continues its investment in technology development, including new engine blades designed to double the time spent in service. Commitment to the modular nuclear reactor programme remains, with a warning that the first reactor may be built in Europe should UK regulators not accelerate approvals. Defence order volumes were also forecast to increase over the coming year.​

Momentum Continues to Accelerate

Rolls-Royce has advanced substantially since hitting its record-low at 650 GBX last year. While it has a long way to go to its all-time high of 940, momentum appears to be building, with no significant pullbacks and trading consistently above its upward trend channel. Although natural pullbacks on the way to 500 and beyond may occur, holding the 335 line could support upside bias. Conversely, a weakness that sees a breach of key support levels at 300 could increase pressure, exposing the 200-230 region.​

Key Takeaways

Rolls-Royce has seen a remarkable turnaround, with operating profits doubling year-on-year to £1.6 billion in 2023, driven by a recovery in demand from airlines seeking to meet rising passenger demand. While the company is making strong progress towards quadrupling profits, it is not yet returning capital to shareholders as it focuses on strengthening its balance sheet and committing investment to technology development. Nonetheless, Rolls-Royce expects the positive momentum to continue, with further profit growth and debt reduction anticipated, indicating that management may feel comfortable restarting payouts soon.​