Rolls-Royce shares decline and upcoming trading update, Digi Mart USA News: Rolls-Royce (LSE: RR) shares have climbed sharply since chief executive Tufan Erginbilgic took charge, but the question now is whether they have risen too far, too fast. The share price has fallen around 20% from its August peak, leaving investors who missed the rally wondering whether a new buying opportunity has emerged.
The shares became very expensive after their strong run, with the price-to-earnings ratio approaching 50 times. That compares with an FTSE 100 average of around 16 times, which leaves the stock vulnerable to profit-taking.
More recently, concerns about an AI bubble deflating have added to the worry.
Rolls-Royce’s Power Systems division, which accounts for around a quarter of profits, has grown strongly by supplying power generation equipment to data centres for both back-up and, increasingly, prime power. However, data centres are becoming unpopular, and if their development is blocked or becomes too expensive, investors may question how much more growth the company can get from this opportunity.
The Defence division continues to perform strongly, with first-half underlying operating profit up 57% to £522m. Civil Aerospace is also doing well, with large engine flying hours reaching 113% of pre-pandemic levels in the first half.
That performance is notable given the Iran war, which has sent jet fuel prices sharply higher and raised the threat of shortages. This could ultimately push up ticket prices and dent passenger demand.
Flying activity has proved remarkably resilient, but conditions could tighten.
Rolls-Royce has several promising opportunities. It is developing small modular nuclear reactors, with contracts in Britain, the Czech Republic and Sweden.
A new £2.5bn government-backed programme to develop next-generation engines could also open up the large and potentially lucrative single-aisle aircraft market. However, these are long-term prospects, and there is still a long way to go.
Even after the recent retreat, Rolls-Royce shares remain expensive, with a trailing P/E of 41. The forward P/E of 27 is more reasonable, but the stock is hardly a bargain.
Engine durability remains a challenge, particularly for the Trent XWB-97, and airlines want proof that reliability is improving before placing more orders. Supply chain problems could also restrict production and cash flow.
If aviation demand weakens, the lucrative aftermarket business could suffer.
The board previously raised its 2026 operating profit forecast to between £4.7bn and £4.9bn, with free cash flow of £3.8bn to £4bn. That is impressive, but expectations are so high that investors may be disappointed if Rolls-Royce does not exceed both targets.
Rolls-Royce publishes its next trading update on Thursday, November 12, giving Erginbilgic an opportunity to reassure the market. If he can do so again, the shares could enjoy an immediate lift.
The source describes Rolls-Royce as a terrific company worth considering after this setback, but notes that with much going on and plenty of scope for further setbacks, it may be wise to wait for a cheaper entry price.
