Regulatory Delays In SMR Projects Will Escalate Costs And Reduce Returns

Key Takeaways

• Rolls-Royce's revenue projections may be overly optimistic, relying heavily on LTSA growth, engine performance, and contract renegotiations amidst competitive challenges.
  
• Strategic moves into SMRs and new technologies entail high investment and regulatory risks, which could affect revenue growth and capital returns.
  
• Rolls-Royce's robust operating performance, cost reductions, and strategic investments are driving profit growth, financial stability, and competitive market positioning.

Catalysts

Develops and delivers complex power and propulsion solutions for air, sea, and land in the United Kingdom and internationally.

• Rolls-Royce's focus on growing the LTSA (Long-Term Service Agreement) balances could suggest overly optimistic revenue projections, as the company assumes continued growth in engine flying hours and improvements in LTSA margins, potentially leading to overestimation of future cash flows and profits.
  
• The anticipated significant improvements in time-on-wing performance by doubling it for certain engines, while potentially reducing shop visits, might not materialize as expected or may face competitive and operational challenges, impacting profit margins and cash flow projections.
  
• The restructuring of the Power Systems business, focusing on larger, higher-margin products and growing data center demand, carries execution risks. If market growth doesn't meet expectations, revenue forecasts could be overstated.
  
• The dependence on renegotiating OE (Original Equipment) and aftermarket contracts to achieve profit growth might pose a risk if these renegotiations fail to secure more favorable terms, potentially affecting net margins and earnings.
  
• The strategic expansion into SMRs (Small Modular Reactors) and other new technologies requires substantial investment and assumes regulatory approvals and market demand will align favorably. Delays or obstacles in these areas could lead to increased costs and impact expected revenue growth and return on capital.

Rolls-Royce Holdings Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Rolls-Royce Holdings's revenue will grow by 4.7% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 13.3% today to 10.6% in 3 years time.
• Analysts expect earnings to reach £2.3 billion (and earnings per share of £0.29) by about March 2028, down from £2.5 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting £2.7 billion in earnings, and the most bearish expecting £1.9 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 31.0x on those 2028 earnings, up from 24.9x today. This future PE is greater than the current PE for the GB Aerospace & Defense industry at 21.7x.
• Analysts expect the number of shares outstanding to grow by 0.19% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 6.94%, as per the Simply Wall St company report.

Rolls-Royce Holdings Future Earnings Per Share Growth

Risks

• Rolls-Royce has significantly improved its operating profit in the civil aerospace sector, with earnings rising by more than 10x due to higher LTSA profitability, business aviation growth, and improvements in spare engine profitability, suggesting potential for continued revenue growth and margin expansion.
  
• The company expects to achieve its midterm targets for profit and cash two years earlier than originally planned, demonstrating a robust operating performance and strategic execution that could positively impact future earnings and financial stability.
  
• Rolls-Royce has reinstated its dividend and announced a £1 billion share buyback, indicating confidence in its cash flow and financial resilience, which could enhance shareholder returns and investor sentiment.
  
• The strategic emphasis on efficiency and procurement savings has led to cost reductions and operating margin improvements, providing a strong foundation for enhancing profit margins across its divisions.
  
• The company's innovative advancements, such as the UltraFan engine and improvements in time on wing, alongside strategic investments in emerging sectors like SMRs, contribute to a strong market positioning and potential for sustained revenue growth and competitiveness in future markets.

Valuation

• The analysts have a consensus price target of £6.843 for Rolls-Royce Holdings based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of £11.5, and the most bearish reporting a price target of just £2.4.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be £21.7 billion, earnings will come to £2.3 billion, and it would be trading on a PE ratio of 31.0x, assuming you use a discount rate of 6.9%.
  
• Given the current share price of £7.44, the analyst price target of £6.84 is 8.7% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.