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Shares in Rolls-Royce (LSE: RR) fell 4.25% today (7 November). As I write, the stock’s now 7% off its all-time high of 592p set a couple of days back.
I invested in Rolls-Royce shares at 149p about 18 months ago, then topped up my holding in August at a price of 450p. Both positions are up. Should I go for a third helping? Or would that be pushing my luck?
What happened
Today’s dip followed a trading update covering the 10 months to 31 October. In this, the FTSE 100 engine maker said flying 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 significant orders from Hong Kong’s Cathay Pacific Airways and El Al Israel Airlines.
It said business remained strong across its defence division, while the power systems unit enjoyed solid revenue growth due to high demand for backup systems in data centres.
CEO Tufan Erginbilgiç commented: “Our transformation of Rolls-Royce into a high-performing, competitive, resilient and growing business continues with pace and intensity. Continued good performance year to date gives us further confidence in the delivery of our 2024 guidance.”
That guidance is for underlying operating profit between £2.1bn and £2.3bn, and free cash flow between £2.1bn and £2.2bn. For context, the underlying operating profit was £1.6bn in 2023, on underlying revenue of £15.4bn. So that’s forecast profit growth of at least 32%.
The dividend’s also back this year, starting at a 30% payout ratio of underlying post-tax profit, rising to a ratio of 30%-40% each year thereafter.
Why’s the stock down?
Given this ongoing progress, why has the stock pulled back? I think there are three reasons.
First, the engineering giant warned back in August that supply chain problems would cost it £150m to £200m this year. Management says the supply chain environment remains “challenging“.
Further delays or shortages in critical components could impact engine production schedules and increase costs. So I’d say this is the most obvious risk here.
Second, Rolls expects engine flying hours at 100%-110% of pre-pandemic levels in 2024. Therefore, the year-to-date 102% figure reported today is towards the lower end of guidance. It doesn’t leave much wiggle room if things go wrong. Missing annual guidance is another risk to the share price.
Finally, the stock has been going gangbusters this year, and is still up around 85% despite this slight pullback. The forward price-to-earnings ratio for next year is around 27, which isn’t that cheap.
Consequently, investor expectations are very high. And with full-year guidance held rather than upgraded, there was probably a bit of profit-taking going on today.
My move
Looking at the update, there’s nothing to worry about here, as far as I can see. The company is on track to deliver what it said it would, while the long-term growth drivers remain strong. These include growing demand for international travel and rising defence spending as nations bolster their armies.
As a long-term investor, I won’t be taking any profit. I intend to hold my shares for the next few years.
But what about buying more? I don’t think this dip is large enough yet, but I’ll keep watching for one that I think is.
