Are Rolls-Royce shares ready for takeoff?

Rolls-Royce shares have faced significant downside throughout the pandemic but shares have recently seen all the benefits of increased air travel scuppered by a poor set of results that missed expectations.

During the pandemic, the company suffered huge losses of nearly £4bn as a result of stringent travel restrictions.

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Rolls-Royce is one of the world’s largest suppliers of jet engines. However, the company’s main source of revenue comes from the maintenance costs of the engines rather than just the sales. This means the company needs planes to be flying to earn revenue.

In 2021, Rolls-Royce saw operating profits of £513m as opposed to losses of £1.9bn in 2020 as the pandemic came to an end.

The company saw revenues over £11bn with largest contributions of £4.5bn and £3.3bn from the civil aerospace and defence segment respectively.

Rolls Royce’s Civil Aerospace division produced revenues of £4,536m in 2021 after recording 7.4m large engine flying hours, up 11% on 2020.

This is set for further recovery in the coming year and will be a key driver of revenue growth and profitability in 2022.

Although the key driver of demand in their Civil Aerospace unit is set to return, there should be caution around the impact of inflation on household spending and a possible reduction in leisure travel.

Defence

With tensions arising on the geopolitical front due to the Russia-Ukraine war, Rolls Royce will likely see an uptick in defence orders as global powers once more refocus their budgets on bolstering their military capabilities.

The defence segment saw an increase of £155m to £3.3bn in 2021 revenues, with an underlying operating loss of £172m.

Rolls Royce have secured a B-52 engine replacement contract with the US which promises a long term revenue source and have recently announced the launch a joint-venture to create a fighter jet engine for Turkey, an TF-X aircraft.

Investors will be watching closely for any surprise contract wins this year.

Power Systems

The revenues in the power systems business division increased by £89m to £2.7bn. Rolls Royce power solutions are focused on clean energy across a diverse range of applications from hydrogen combustion engines to power solutions for a hyperscale data centres.

Rolls Royce is also moving into nuclear power after receiving a $546m funding round supported by the UK Government for Rolls-Royce to start developing their first small modular nuclear reactors.

Earlier in the week, the British government requested the UK nuclear regulators to begin the process of approving Rolls-Royce’s nuclear reactor initiative.

The results from the nuclear reactors should help reduce carbon emissions and fossil fuel dependence, and in time, Rolls Royce revenues.

“We have also made significant progress with our new businesses in electrical power and small modular reactors, both of which have the potential to create very significant long-term value,” said Chief Executive Officer, Warren East.

Warren East is set to leave his post at the helm of Rolls Royce which has dented investor sentiment around Rolls Royce shares.

The power division saw an increase of £67m in underlying operating profit to £242m.

The increase in revenues and underlying operating profits have been observed due to reduced impact of COVID-19 leading to increased order intake in the fourth quarter.

Rolls-Royce Shares Valuation

With Rolls-Royce trading at 93p, the stock has a forward P/E of 29.3x which is high given earnings growth recently missed expectations and margins look weak for 2022.

However, investor sentiment around travel related shares may improve through 2022 and benefit Roll Royce shares, which may swept up in broad-based allocations to the sector.

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