Rising Supply Chain Risks And Slowing Demand Will Undercut Margins

Key Takeaways

• Reliance on exceptional aftermarket and Power Systems growth creates risk if demand normalizes, data center investment slows, or cost pressures re-emerge.
  
• High investor optimism for sustainable technologies may be premature, as these projects face significant execution, regulatory, and commercialization uncertainties.
  
• Ongoing transformation, innovation in next-generation technologies, and expanding clean energy and aerospace markets are enhancing earnings power, financial flexibility, and long-term growth prospects.

Catalysts

Develops and delivers mission-critical power systems in the United Kingdom and internationally.

• The exceptionally strong financial performance and raised guidance appear to heavily reflect surging demand from the civil aviation aftermarket (especially higher shop visits, aftermarket profitability, and improved contract terms), as well as record aftermarket order intake in Defence, both of which are influenced by a spike in global air traffic and backlogged demand post-pandemic. There is a risk this recovery pace will normalize, resulting in softer revenue and earnings growth than implied by current market optimism.
  
• Management is highlighting rapid margin expansion and robust recurring cash flows from renegotiated long-term service contracts and time-on-wing improvements, but these improvements may have front-loaded margin benefits and created high expectations for sustained net margin growth that could be challenged if airlines accelerate adoption of newer, more efficient fleets or structural shifts in business travel reduce long-haul engine utilization.
  
• A significant portion of current narrative and valuation appears premised on Power Systems segment growth-especially the data center power generation boom-continuing at near-peak rates (20%+ per year) as cloud and AI infrastructure expand. Should the data center investment cycle decelerate from these extraordinary levels, revenue growth and margin gains could materially slow, negatively impacting future operating profit.
  
• The growing investor enthusiasm for Rolls-Royce's sustainable technology initiatives (SMRs, UltraFan, hydrogen propulsion, advanced battery storage) is increasingly priced into the stock, yet these projects remain in early commercialization stages and carry material execution, regulatory, and capex risks. If adoption lags or investor timelines prove optimistic, anticipated new revenue streams are likely to be delayed, impacting long-term earnings visibility.
  
• Recent results and the company's strong midterm targets embed the assumption that supply chain and input cost headwinds (notably in aerospace parts and materials) can continue to be substantially mitigated through procurement and efficiency programs. If sustained cost inflation re-emerges or supply chain disruption worsens, it would pressure both gross margins and free cash flow, challenging the durability of current elevated profitability.

Rolls-Royce Holdings Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Rolls-Royce Holdings's revenue will grow by 7.1% annually over the next 3 years.
• Analysts assume that profit margins will shrink from 29.6% today to 12.7% in 3 years time.
• Analysts expect earnings to reach £3.0 billion (and earnings per share of £0.38) by about August 2028, down from £5.8 billion today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting £3.6 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 38.2x on those 2028 earnings, up from 15.3x today. This future PE is greater than the current PE for the GB Aerospace & Defense industry at 24.9x.
• Analysts expect the number of shares outstanding to grow by 0.3% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.84%, as per the Simply Wall St company report.

Rolls-Royce Holdings Future Earnings Per Share Growth

Risks

• Robust growth in core business segments and successful transformation initiatives-such as record operating and free cash flow, strong margin expansion, and significant progress in renegotiating high-margin aftermarket contracts-suggest Rolls-Royce is structurally improving its earnings power, which could fuel higher revenue, profit, and shareholder returns over the long term.
  
• Strategic focus and leadership in next-generation technologies (e.g., time-on-wing improvements, UltraFan engine development, and groundbreaking investments in AI and digitalization) are increasing competitive advantage within secular industry growth trends, supporting sustained or rising net margins and mitigating risks associated with traditional product lines.
  
• Substantial growth opportunities in Power Systems (especially from surging data center demand) and civil/defense aerospace-with large backlogs, double-digit order intake growth, and high recurring revenues-underscore greater earnings visibility and revenue resilience into the late 2020s and beyond.
  
• Successful execution and rapid scaling of the Small Modular Reactor (SMR) nuclear business, already awarded preferred bidder status and large orders, could unlock sizeable new, long-term revenue streams and cash generation across emerging clean energy markets, enhancing group earnings diversification and stability.
  
• A strengthened balance sheet-now in net cash, ongoing debt reduction, and rising shareholder distributions (dividends and buybacks)-combined with improved credit ratings, provides financial flexibility for further investment, shields against macro shocks, and positions Rolls-Royce to benefit from favorable secular trends, supporting potential long-term value accretion and upward share price momentum.

Valuation

• The analysts have a consensus price target of £10.954 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 £14.4, 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 £24.0 billion, earnings will come to £3.0 billion, and it would be trading on a PE ratio of 38.2x, assuming you use a discount rate of 7.8%.
• Given the current share price of £10.56, the analyst price target of £10.95 is 3.5% higher. 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.