Rolls-Royce (LON: RR) share price has gone parabolic this year, rising by 80%, making it one of the best performers in the FTSE 100 index. It has surged by more than 1,300% from its lowest level in 2020, when it nearly went bankrupt.
RR shares have jumped under Tufan Erginbilgiç
Rolls-Royce shares have done well under Tufan Erginbilgiç, the well-compensated executive who took over in January last year. He is probably best known for his description of the company as a burning platform.
The stock has risen by 440% since he became CEO, which has made him relatively wealthy. Data shows that he was the third best-compensated executive in the FTSE 100 index after AstraZeneca and Relx CEOs.
He has also netted over £32 million in paper profits in the 9.3 million shares he has was awarded.
However, analysts are unsure whether the ongoing surge can be attributed to Erginbilgiç or whether he is just lucky. I believe that luck and his management style have contributed to the ongoing stock surge.
On luck, the company has done well because of the global macro events that have led to robust civil aviation business. It has also benefited from the ongoing geopolitical events that have led to more demand for military equipment.
Civil aviation is an important part of Rolls-Royce’s business since it generates over 50% of its revenue. It does that by selling engines that power planes like the Airbus A330-neo, A380, and A330.
RR then makes most of its money by entering long service contracts that it charges for every flight hour. Therefore, its business has benefited as most airlines have seen elevated demand, with their load factors rising to pre-pandemic levels.
As such, Erginbilgiç was lucky because he became CEO when this recovery happened. It is also worth noting that the stock was already rising before he became CEO.
Most importantly, other companies in the industry have done well, with the GE Aerospace stock rising by 150% in the last 12 months. Safran, which has an engine manufacturing joint venture with GE, has risen by 45% in the same period. Similarly, RTX, which owns Pratt & Whitney, has jumped by 75% in the last 12 months.
Increased defense spending
Rolls-Royce share price has also soared because of its defense business, which has benefited from the ongoing spending by governments.
The war in Ukraine is going on while the Middle East is on edge after Israel launched a ground operation in Lebanon.
There are also growing risks that China will invade Taiwan in the next few years, a move that will force the US and its allies to respond. As a result, most Western countries, especially those in NATO, have start making these preparations.
Rolls-Royce is also benefiting from the AUKUS arrangement that unites the United States, UK, and Australia, with Japan expected to join.
Altogether, the defense segment’s revenue rose by 18% in the year’s first half while the civil aerospace jumped by 27% to £4.1 billion.
Cost cuts and new targets
Tufan Erginbilgiç’s actions have also helped the Rolls-Royce share price recover. He has done that by reducing costs, refocusing the company on profitability, changing senior leaders, reduced duplication, and culling middle managers.
At the same time, he has abandoned some of his predecessor’s loss-making ventures and set new profit targets for the company.
As part of his strategy, he hopes that the operating profits will rise to between £2.5 billion and £2.8 billion in the medium term. He also expects that the operating margin will grow to between 8% and 10% while its free cash flow will be between £2.8 billion and £3.1 billion.
These actions, together with the return of dividends, have led to more demand for the company’s stock.
Risks remain
It is still too early for Erginbilgiç to celebrate since a lot can happen. Besides, the civil aviation division that has done so well is highly cyclical.
Also, history shows that stocks that climb so fast can also suffer a sharp reversal. Two good examples of this are Boohoo and Burberry.
Boohoo was a tech darling during the pandemic when its stock surged to 433p. Today, it has plunged to below 30p. Similarly, Burberry shares surged to 2,458p in 2023 and has dropped to below 800p today.
There is also risk that the stock has become highly overvalued. Most notably, the Relative Strength Index (RSI) and MACD show that the stock has started to form a bearish divergence pattern. In most periods, this pattern is usually followed by a bearish breakout.
Therefore, the stock may continue rising as investors wait for its trading statement in November when it publishes its trading update. It will then start falling towards the end of the year.
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