Will the Rolls-Royce share price continue to defy gravity?

In the midst of the pandemic, investors would have baulked if you’d said the Rolls-Royce share price would become one of the hottest stocks in the FTSE 100 within a few years.

The company endured years of turmoil prior to the arrival of Tufan Erginbilgic, including a brush with bankruptcy and a £671m fine stemming from investigations into whether it had paid bribes to secure contracts.

But since he took the top job just over a year and a half ago, the turnaround has been nothing short of remarkable.

The Turkish businessman, known affectionately as ‘Turbo Tufan,’ has overseen a more than quadrupling in the Rolls-Royce share price and a string of stellar results.

In its most recent half-year update, Rolls reinstated dividends, hiked full-year profit guidance to upwards of £2.3bn and rewarded its more than 40,000 employees with £700 each in stock.

The performance has left the stock up over 45 per cent this year, that’s despite the wider market pullback in recent days.

But the question for investors is, how much longer can the company’s performance continue?

The outlook for the Rolls-Royce share price

Key to Rolls’ performance will be wider market trends in both defence and aviation.

The largest segment of the business is devoted to building engines for airlines, and a two-year post-pandemic boom in travel demand has lifted orders.

However, following downbeat results in recent weeks from Ryanair, Europe’s largest airline by passenger numbers, and Wizz Air, there is concern the boom may be coming to an end.

Late July saw a sell-off in airline stocks, with the likes of Ryanair, Easyjet and British Airways parent company IAG, tumbling in value.

Airlines are still investing heavily in their fleets, however. “A recovery in the aviation industry was always likely to translate into higher earnings for Rolls-Royce. The amount of time planes fly in the sky has a direct impact on the amount it makes on spares and repairs contracts for a large installed base of aircraft engines,” Dan Coatsworth, an analyst at AJ Bell, said.

“This installed base itself is also growing. Airlines are investing heavily to expand their fleet as they add new routes and seek more energy-efficient planes.”

“This installed base itself is also growing. Airlines are investing heavily to expand their fleet as they add new routes and seek more energy-efficient planes.”

In Rolls-Royce’s defence business, rising global geopolitical tensions, coupled with successful contract wins in the form of the Aukus Tri-lateral partnership, have boosted its order book.

Global military spend looks unlikely to die down anytime soon, with conflict in the Middle East and Ukraine ongoing.

Gains across the firm are contributing to “material increases in profitability and cash flow generation,” Aarin Chiekrie, equity analyst at Hargreaves Lansdown, said. These are “moving higher at an eye-watering pace,” he added.

“With so much improvement in such a short period of time, Rolls-Royce is already more than halfway to achieving its 2027 mid-term guidance, not even a year after it was announced.”

Another boost could come from the FTSE 100 giant’s budding small nuclear reactor business.

Rolls-Royce is currently close to winning a major government tender, led by Great British Nuclear (GBN), to develop so-called Small Modular Reactors (SMRs), essentially scaled-down versions of nuclear power plants.

“The new UK government is pro-nuclear power which plays into Rolls-Royce’s strengths as Labour has shown interest in small modular reactors, something the UK engineer has been developing. It has designed a factory-built nuclear power plant that it believes will offer clean, affordable energy ‘for all’,” Coatsworth said.

The performance can’t last forever, though. Peaks often lead to troughs and a tail-off in the aviation industry will likely be the first to slow Rolls-Royce’s growth.

“Smashing expectations with its latest results goes some way to justifying its premium share rating, but it also means this feat has to be repeated again and again. Otherwise, investors might take anything less as a reason to bank their profits,” Coatsworth explained.

But for now, it only looks positive. “The growth opportunities are big and the company is on a roll, so it is understandable why investors might feel they want to stick with the shares even after a 600 per cent rise since October 2022,” the analyst continued.