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Rolls-Royce (LSE: RR) shares were recently powered over 500p after the engine maker's H1 results. This high record has some investors worried about FTSE 100 the high-flier arrived before it.
That may be true in the near term, with the stock trading at about 30 times forward earnings. But that didn't stop me buying more shares in my ISA recently at 477p. Here are four reasons why I do so.
Firing on all cylinders
First, I was very impressed with the company's H1 results. It was hard not to be there. Revenue rose 19% year-on-year to £8.2bn, with growth across all three key categories. Operating profit jumped 74% to £1.1bn, while margin increased 4.4% to 14%. Free cash flow more than tripled to £1.2bn.
Meanwhile, total debt has now fallen to £822m, the lowest in more than five years. This has been recognized by credit rating agencies, with two out of three now rating the company as investment grade.
Looking ahead, the company expects an operating profit under 2024 of £2.1bn-£2.3bn, down from its previous guidance of £1.7bn-£2bn. It also expects free cash flow of £2.1bn-£2.2bn rather than £1.7bn-£1.9bn.
The dividend is back
Second, the dividend was returned after more than five years. The company will start by paying 30% of the basic after-tax profit before an ongoing payout ratio of 30-40% each year.
Admittedly, the dividend yield in 2025 is puny, at just 1.2%. But I hope the payout will grow well over time given the incredible free cash flow development.
In retrospect, this restoration is symbolic given the financial crisis the Rolls faced during the pandemic. The rapid turnaround under CEO Tufan Erginbilgiç has been surprising.
High target price
Next, the consensus share price target from analysts is currently 542p. That is still about 8.8% higher than the current level.
Naturally, these price targets are not guaranteed and have risks. Another is that many international airlines are suspending flights as tensions rise in the Middle East. If the conflict escalates, this could lead to a decrease in demand for new planes and engines. Major supply chain issues also persist across the industry.
The future looks bright
However, in the long term, the investment case still looks strong to me. In the next 20 years, the number of flights is expected to double, according to Boeing again Airbus. This will be driven particularly by China and India, where Rolls-Royce has positioned itself to capture the many opportunities arising from this growth.
Then there are small modular reactors (SMRs), which are smaller versions of a nuclear power plant. This is no longer the stuff of science fiction. The UK government is likely to soon award the contract and Rolls-Royce could be at the front of the queue.
Sweden and the Czech Republic have been paying attention to Rolls' SMR technology and I'm sure they won't be the last. After all, those decarbonisation targets enshrined in law are very close.
Understandably, this opportunity is not reflected in the stock price today. But I'm investing here with a minimum view of five years, so I hope it will be one day.
Each SMR will cost around £2bn-£2.5bn, so this could be a really big new growth market for Rolls-Royce in the early 2030s.
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