Rolls Royce Adds to Impressive Gains

The first impressions are that Rolls Royce's turnaround is working, seeing its stock price surge around 120% since the beginning of the year and up 10% in August alone after reporting a five-fold increase in earnings for the second half, with month-to-month gains over 30%.

After Take Off, Will There Be a Smooth Climb?

The new CEO of Rolls Royce, Tufan Erginbilgec, joined in January with the mission to turn around the company, battered by cost issues and the pandemic that grounded flights using its engines. The recovery in aviation over the last year has certainly helped the aircraft engine provider, particularly the resumption of long-haul flights using aircraft like the Airbus A350 and Boeing 787 powered by RR engines. Last month, the company reported a net profit of £673M, more than five times the £142M in underlying profits it reported a year ago.

To make things even more appealing to investors, the company also raised its guidance for the rest of the year and now sees Operating profit at £1.2-1.4B, which could mean the poor performance is finally over. But what was likely more interesting for shareholders is the increased guidance for free cash flow to £0.9-1.0B, which could give more room for future returns to investors. Rolls Royce saw an 88% increase in its free cash flow in the first half and has decided to plough the bulk into deleveraging.

Streamlining for the Future

Net debt in the first six months of the year was cut from £3.25B to £2.86B to bring down the company's liabilities which last half cost £149M in interest payments. Debt servicing cost over a third of Rolls Royce's net profits. Cutting back the company's gearing might help improve profits in the longer term and allow access to cheaper debt when interest rates eventually come down.

But that's looking at at least a two to three-year timeframe. Short-term investors might be disappointed that more of the company's renewed profitability and cash flow isn't being directed towards shareholders, which could slow the rise in the stock's price while interest rates remain high. On the other hand, if the new management can keep the current profitability trends growing, the UK's premier engine maker could return to being an attractive long-term investment.

Post-Triangle Breakout Slowdown

Despite being far from record highs, price action appears primed for the long term while 150 GBX holds firm as it marks the top of the range 65-150 GBX breakout, bringing the measured-move projection at 235 GBX into the spotlight.

The near-term ascending-triangle breakout has extended nearly reached twice the measured-move target at 215 GXB, but also implies a short-term pullback may be due. Ideally, 150 GBX holds if 175 GBX softens, with a breakdown below opening the door to 105 GBX. Additional run-ups could see prices head towards 250 GBX.

Source: SpreadEx / Rolls-Royce Holdings

Key Takeaways

Rolls Royce's stock price soared over 30% in just one month and 120% year-to-date, spearheaded by CEO Tufan Erginbilgec, who joined in January to tackle cost issues and pandemic-related challenges. The recovery of the long-haul flights powered by Rolls Royce engines played a crucial role in the company's improved performance. Rolls Royce reported a net profit of £673M, more than five times the previous year's underlying profits. Additionally, the company raised its guidance for operating profit and free cash flow while actively reducing its net debt to improve its financial position. This positive trajectory positions Rolls Royce as a potentially attractive long-term investment.