Is Rolls-Royce share price about to go nuclear?

The Rolls-Royce share price took off last week after the jet-engine maker upped profit and free cash flow guidance in a surprise trading update. In the update, Rolls-Royce said its civil aerospace and defence segments had delivered stellar operating profits. Elsewhere, the UK government has hinted that Rolls-Royce is well-positioned to help its nuclear power ambitions.

• Rolls-Royce share price up 24% last week after upping profit and free cash flow guidance in a surprise trading update.
• BofA Merrill Lynch ups price target on Rolls-Royce shares from 190p to 260p.
• The jet-engine maker is in the running to build small nuclear plants in the UK.

Rolls-Royce [RR.L] share price jumped 19% on Wednesday last week after the engine maker upped its earnings and free cash flow targets for the year in a surprise trading update. Rolls-Royce now expects £670m in operating profits for the first half of the year, thrashing consensus expectations of less than half that amount.

Rolls-Royce also upped its full-year guidance for operating profits to between £1.2bn and £1.4bn, topping consensus of £934m. Free cash flow is now expected to come in between £0.9bn and £1.2bn, ahead of the £732m consensus.

CEO Tufan Erginbilgic said the stronger-than-expected results are anticipated on the back of promising signs from the company’s transformation programme, despite supply-side challenges.

“Despite a challenging external environment, notably supply chain constraints, we are starting to see the early impact of our transformation in all our divisions. Better profit and cash generation reflects greater productivity, efficiency and improved commercial outcomes,” said Erginbilgic.

Civil Aerospace profits fuel Rolls-Royce shares

Along with increased profit guidance, Rolls-Royce shares were fuelled by a turnaround in two key divisions. The company’s civil aerospace operating profits are expected to be approximately £400m in the first half of the year, reversing a £79m loss in the same period the previous year. Rolls-Royce said that the turnaround in profits was due to higher aftermarket performance, with the company benefitting from increased demand for engine repairs.

Rolls-Royce makes money from the hours its engines are up in the air. The company said that it expects engine flight hours to be 80–90% of 2019 levels, with 400–500 engine deliveries.

Defence profits are forecast at £260m in the first half of the year, up from £189m last year. Rolls-Royce said that delivery had been more even in the first half of this year compared to the second half of 2022, adding that margins were higher thanks to a favourable product mix and cost efficiencies.

The company’s power systems segment lagged the outsized growth of civil aerospace and defence with first-half operating profits of £120m, up £1m from the same period in the previous year. Rolls-Royce said it anticipates higher margins for this side of the business for the full year.

Rolls-Royce’s share price predictions

Rolls-Royce’s share price has been one of the strongest performers on the FTSE 100 this year, with the stock rising over 107% so far in 2023, closing Friday, 28 July, at 193.3p. That’s in stark contrast to a dismal 2022 when Rolls-Royce’s share price sunk over 24%.

The background to the renaissance in Rolls-Royce’s shares is a recovery in demand. Last year, operating profit came in at underlying operating profit of £652m, up £238m over the previous year, with Rolls-Royce pointing to an increase driven by its civil aerospace and power systems businesses. Last week’s trading update underlined the return in demand.

Following last week’s trading update, Bank of America Merrill Lynch analysts upped their price target on the Rolls-Royce share price from 190p to 260p, suggesting a 37% upside on Friday’s close.

"After three years of depressed earnings, the widebody recovery is on track, strongly supporting Rolls free cash flow generation," the analysts said.

The analysts said that there was more upside left in civil aerospace and defence and room for more cost-cutting in power systems.

Rolls-Royce share price has a 12-month median price target of 168p, suggesting a 13.1% downside on Friday’s close.

Rolls-Royce in the running for government nuclear contract

Earlier in July, energy secretary Grant Shapps told the Financial Times that Rolls-Royce was in “a good position” to develop small modular power stations, which could help the UK meet its target of generating a quarter of its electricity from nuclear power. The company has already received £210m in government grants to develop its proposals.

However, it's not necessarily a done deal. Rolls-Royce is competing with GE Hitachi and X-energy to develop small nuclear reactors. A shortlist of technologies is to be drawn up in autumn, with a decision to be made in the next parliament.

Where next for Rolls-Royce?

Erginbilgic described Rolls-Royce as a “burning platform” when he took charge at the start of the year. Erginbilgic said that the pandemic couldn’t solely be blamed for the engine maker’s travails.

To streamline the business, Erginbilgic has overseen cuts to the workforce, merged departments and jettisoned a carbon capture scheme. A combination of more efficiencies and a return in demand seems to be paying off for the Rolls-Royce share price.

More details on first-half performance will be available on Thursday, 3 August, when Rolls-Royce publishes its full 2023 half-year results. After that, there is a strategic review due out later in the year. Both will influence how much further Rolls-Royce’s share price can fly in 2023.