We all know by now that Rolls-Royce shares have delivered mind-boggling returns since the pandemic. It was the greatest comeback since Lazarus and you don’t need me to rehash the numbers.
But that’s in the past. What I want to know is which UK shares could possibly do a Rolls-Royce over the next few years.
To get some ideas, I turned to artificial intelligence (AI). You know, the technology that some experts reckon has a 10% chance of wiping out humanity before 2030.
I asked ChatGPT (the free version) for some ideas. Here’s what it came up with…
A quintet of candidates
The chatbot gave me five stocks: BAE Systems, Babcock International (LSE:BAB), Melrose Industries (LSE:MRO), Games Workshop, and Halma.
Now, I’m going to discount life-saving technology group Halma and Warhammer maker Games Workshop. They’re both terrific companies (I hold Games Workshop), but I see them as quality compounders rather than turnaround candidates.
I mean, Halma just reported its 23rd consecutive year of adjusted profit growth, and 47th straight year of dividend growth of 5% or more. Reflecting this quality, the stock’s trading at a premium of 26 times forward earnings, even after a recent dip.
Likewise, Games Workshop commands a premium valuation due to its software-type margins. It just announced that year-to-date trading is in line with expectations, indicating resilience despite inflation-weary consumers remaining under pressure.
I’m also going to rule out defence giant BAE Systems. Again, great company (I hold its shares), but it already has a £62bn market cap. It’s not what I was looking for.
The remaining two
So this leaves us with defence and engineering company Babcock and aerospace group Melrose. Both are set to benefit from higher defence spending but are far smaller than BAE, with market caps under £6.5bn.
However, Melrose has more direct parallels with Rolls-Royce because it makes money from engines, airframes and other aerospace components.
Our clear growth strategy is underpinned by attractive end markets, differentiated technology and established positions on the world’s leading civil and defence aircraft.
Melrose Industries.
The company has faced challenges after an evacuation incident involving an overheating chemical tank at a GKN Aerospace facility in Los Angeles in May. Since then, the site has been running at 50%, reducing revenue, operating profit and cash by roughly £6m per month.
A £175m share buyback programme has been paused and a $100m compensation pot set up. Melrose is targeting 28 September to resume full production, but any delay to that would cost it more money and may spark a sell-off in the shares.
As for Babcock, most of its revenue comes from the UK, including refuelling and refitting the Royal Navy’s nuclear submarines. Its growth prospects hinge on the government stumping up the cash for higher defence spending, which is proving difficult.
Which one?
In truth, I don’t see either stock producing Rolls-Royce-esque returns from here. Nevertheless, both companies have bright long-term growth prospects, in my opinion.
Their shares look good value, with Melrose trading at just 11.5 times forward earnings. I think both are worth a closer look.
But to find the next potential Rolls-Royce, we’re going to have to rely on our own human rather than artificial intelligence. Then hope we’re all still around in the 2030s to enjoy any cash returns.
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Ben McPoland owns shares in BAE Systems, Games Workshop, and Rolls-Royce.
This story originally appeared on Motley Fool
