Image source: Getty Images
Actions in Rolls-Royce (LSE: RR) fell 4.25% today (7 November). As I write, the stock is now 7% away from its all-time high of 592p set a couple of days ago.
I invested in Rolls-Royce shares at 149p about 18 months ago and then increased my holding in August at a price of 450p. Both positions are up. Should I opt for a third helping? Or would that be pushing my luck?
What happened
Today's drop followed a trading update covering the 10 months to October 31. In this, the FTSE 100 The engine maker said flight hours in its key civil aerospace business grew 18% year-on-year, reaching 102% of pre-pandemic levels.
Rolls-Royce plans to deliver between 500 and 550 new engines this year, with major orders from Hong Kong. Cathay Pacific Airways and El Al Israel Airlines.
It said business remained strong across its defense division, while the power systems unit enjoyed strong revenue growth due to high demand for backup systems in data centres.
CEO Tufan Erginbilgiç commented:Our transformation of Rolls-Royce into a high-performance, competitive, resilient and growing business continues with pace and intensity. Continued good performance so far this year gives us greater confidence in meeting our 2024 guidance..”
That guidance is for underlying operating profit of between £2.1bn and £2.3bn, and free cash flow between £2.1bn and £2.2bn. For context, underlying operating profit was £1.6bn in 2023, on underlying revenue of £15.4bn. So profit growth of at least 32% is expected.
The dividend also returns this year, starting with a payout ratio of 30% of underlying profit after tax, and increasing to a ratio of 30%-40% each year thereafter.
Why are stocks down?
Given this continued progress, why has the stock pulled back? I think there are three reasons.
Firstly, the engineering giant warned in August that supply chain problems would cost it between £150m and £200m this year. Management says the supply chain environment remains “challenging“.
Further delays or shortages of critical components could impact engine production schedules and increase costs. So I would say this is the most obvious risk here.
Second, Rolls expects engine flight hours to be between 100% and 110% of pre-pandemic levels in 2024. Hence the 102% year-to-date figure reported today It is located at the lower end of the orientation. It doesn't leave much room for maneuver if things go wrong. The lack of annual guidance is another risk to the share price.
Finally, the stock has had great success this year and is still up around 85% despite this slight pullback. The forward price-earnings ratio for next year is around 27, which is not that cheap.
Consequently, investor expectations are very high. And with full-year guidance maintained rather than improved, there was probably a bit of profit-taking today.
my movement
Looking at the update, there is nothing to worry about as far as I can see. The company is on track to deliver on what it said it would do, while long-term growth drivers remain strong. These include growing demand for international travel and increased defense spending as nations strengthen their militaries.
As a long-term investor, I will not make any profit. I intend to hold onto my shares for the next few years.
But what about buying more? I don't think this drop is big enough yet, but I'll keep an eye out for one that I think is.
