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The Rolls-Royce (LSE:RR) share price continues to defy gravity, with the stock up 92% in the last year. However, the pace of growth has been stunted in recent months, with it up a modest 11% in the previous three months. At around 900p, I feel that another 10%+ move to take out 1,000p (£10) is going to be tricky, but certain catalysts could make it happen over the next year.
Focus on the future
Stronger order books for small modular reactors (SMRs) could help trigger another rally in the stock. A breakthrough could also come via a new UK government funding round or a foreign licensing deal. Basically, any news that helps validate this division as a potential multi-billion-pound business.
SMRs offer stable, carbon-free baseload power, making them a crucial complement to renewables. That’s why Rolls-Royce (along with other companies) is investing heavily in producing and deploying the reactors. The public company is the majority shareholder of Rolls-Royce SMR Ltd, so any benefit derived will pass through to shareholders.
Additional value needs to be created in order to hit 1,000p. Each SMR generates around £200m of EBITDA (earnings before interest, tax, depreciation, and amortisation) over its lifetime. It aims to deploy 10-15 SMRs in the UK by 2040. Rolls-Royce hasn’t mentioned international numbers, but demand from foreign governments could also be large.
Let’s assume there’s another 10-15 internationally. This would generate £4bn-£6bn in profits, which would easily justify a £7bn-£8bn increase in market cap to allow the stock to hit 1,000p. Investors wouldn’t wait for years before factoring this in. If we get signs in the coming months that the rollout and build times are doing well, people could start to buy the stock based on the future potential of these earnings.
Higher profit margins
CEO Tufan Erginbilgiç’s transformation plan aims to increase operating margins to 15%-17% by 2027. The business is doing well in this area. The 2023 figure of 10.3% rose to 13.8% last year. It’s encouraging that the annual report said that “all core divisions delivered significantly improved performance”.
If the margins increase faster than expected, this could help lift the share price. Based on the operating profit from last year, if it increases this year by 3%, to 16.8%, this would be almost an extra £75m! If this is combined with lower indirect costs, net profit could get a chunky boost in excess of 10%. If could also cause a similar boost to the share price as investors cheer the faster pace of financial improvement.
However, there are risks, such as global tariffs and macroeconomic uncertainty. Given the international nature of operations, the business has spoken about this earlier this year. Tariffs threaten to increase costs and delay projects, ultimately hindering profitability.
Overall, I’m being patient and will consider buying the stock if these two catalysts — a jump in business for SMRs and improved profit margins — start to materialise.
This story originally appeared on Motley Fool
