You would be forgiven for thinking Rolls-Royce (LSE: RR.) shares are about to run out of steam. After an incredible surge of 1,209% in the last five years – supported by win after win in aeroplanes, defence, nuclear power, and even powering data systems for artificial intelligence, the share price must be due for a pull back, mustn’t it?
Rolls-Royce CEO Tufan Erginbilgiç probably would disagree. He has just confirmed big plans for the company to take on perhaps its biggest market yet. He called it a “massive 50-year growth opportunity”.
What’s the news? Rolls-Royce plans to enter the narrow-body aircraft engine market. The current engines the firm makes for civilian aircraft are for wide-body aircraft – the bigger type of aeroplane with multiple gangways – that are most often used for long-distance flights.
Why is this such a big deal? Because of the size of the opportunity. The smaller narrow-body aeroplanes account for the majority of fleets worldwide. That’s a huge market that Rolls-Royce has to tap into. And let’s remember that civilian aeroplane engines is the company’s biggest division, accounting for nearly half of sales.
Another fact in its favour is the numerous aircraft production delays at the moment, often caused by current engines. Something smells of opportunity…
A large amount of those revenues are drawn not from sales of the engines themselves, but from the long-term maintenance and upkeep. This is why Erginbiligiç can talk in timeframes of five decades. And why the shares might have a very bright future.
The future is really the watchword here. The new engines are designed to be able to run on 100% “sustainable aviation fuel” – made from renewable or biofuel with far fewer greenhouse gas emissions – from day one of service.
Last word
What are the negatives here? For one, this is just a proposal. Nothing has happened yet. The narrow-body market might prove a tough nut to crack a few years down the line.
And despite its size, Rolls-Royce is now firmly priced as a growth company. The forward price-to-earnings ratio sits at around 40, yet the engineering firm is now a £104bn market cap company and the fifth-largest on the FTSE 100.
Another drawback is the difficulty of manufacturing in this country. This was exemplified in the recent news that the US and Germany are trying to win a project with the company for 40,000 jobs. Industrial energy costing a quarter the price sometimes over the Atlantic could pose a challenge for a firm that uses a lot of the stuff.
The last word? Rolls-Royce has been proving the critics wrong for years now. While there are no guarantees this new foray into smaller aeroplane engines will hit it out of the park, I’d not like to be betting against it. I think the stock is one to consider.
