Any stock, including Rolls-Royce Holdings (LSE:RR), that’s seen the price of its shares soar by around 750% in three years is likely to run out of steam at some stage.
Indeed, so far this year, the share price of the aerospace, defence, and power systems group has failed to excite. It’s now (11 June) back to where it was in early January.
Is this a case of investors pausing for breath, or a sign that many believe the stock’s overvalued? Let’s discuss.
What’s happening?
Like so many others, the stock’s been affected by the war in Iran. Not only has there been a loss of investor confidence across the market, but with over 60% of the group’s operating earnings coming from its aircraft engines business, worries about the impact of the conflict on the aviation industry are likely to have contributed.
The cancellation of flights on safety grounds — and the soaring price of jet fuel — has clearly hurt the world’s airlines.
Keep calm and carry on
However, Rolls-Royce’s last trading update was remarkably positive. In April, the group said it expects to “fully mitigate” the disruption to its business. There were no caveats to this statement and no warnings that this might change if the conflict continued and the Strait of Hormuz remained closed.
Looking ahead, it said: “We continue to monitor the situation for any future direct and indirect impacts and will take the necessary actions to mitigate them.” I note the use of the word ‘will‘. Again, this implies there are no doubts in the minds of Rolls-Royce’s directors that the group will be largely unaffected.
In part, this is due to its diversified business model. Its defence division will be a beneficiary from geopolitical uncertainty. And its power systems unit is helping to meet the needs of AI data centres. But could this continue?
More to come?
Analysts are expecting earnings per share (EPS) of 37.8p in 2026. If achieved, this would be a 27.7% improvement on 2025. By 2028, they’re forecasting an increase of 75% to 51.8p. With a forward (2028) price-to-earnings ratio of 24.5, the stock looks to be competitively priced.
And if recent history is anything to go by, these forecasts could be upgraded. For example, when presenting its 2023 results, the group said it was targeting an underlying operating profit of £2.5bn-£2.8bn in 2027. The current thinking is that this will be around £4.7bn.
Of course, things could change quickly if there’s any sign of a slowdown. No matter how confident its directors might be, the group would suffer if there was a prolonged downturn in the aviation industry.
And a global recession would affect all of its business units to some degree or another. In these circumstances, the EPS targets referred to earlier would become a bit of a stretch. I suspect fears like these explain the current lacklustre share price.
Final thoughts
However, for the time being, it’s business as usual. Longer term, the group’s hoping that its small modular reactor programme and return to the narrowbody aircraft engine market will add two more strings to its bow.
Personally, I think the stock’s still one to consider. Indeed, the 13% drop in the group’s share price from its 12-month high could be a good entry point for new investors.
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James Beard owns shares in Rolls-Royce Holdings plc.
