The Rolls-Royce share price surges 10% as H1 smashes expectations. What next?

The Rolls-Royce Holdings (LSE: RR.) share price has been a huge growth success story. But to keep it going, the company needs to continue performing. So did first-half results Thursday (31 July) hit the mark? Yes, emphatically. Operating profit jumped 50% to £1.7bn. And free cash flow reached £1.6bn.

Full-year guidance? Rolls set itself some even more stretching targets. They include underlying profit between £3.1bn and £3.2bn, with free cash flow of £3bn to £3.1bn.

With 2024 full-year results released in February, guidance was set at £2.7bn to £2.9bn for operating profit and the same for cash flow. That’s an impressive hike, just five months on.

Share price

What happened to the Rolls-Royce share price in response? The soaring climb of the past couple of years shown in the chart below might hide it. But in early trading, the price surged. It’s up over 10% at the time of writing.

What next?

CEO Tufan Erginbilgic’s statement echoed much of his usual enthusiasm — which does seem justified yet again. I was struck by “Rolls-Royce SMR was selected as the sole provider of the UK’s first small modular reactor programme. We expect Rolls-Royce SMR to be profitable and free cash flow positive by 2030.”

There’s no profit from the division yet. But that timescale could be handy. Analysts currently predict 9% growth in earnings per share between 2024 and 2027. That’s nice, but I fear it might not be enough to keep the share price going much further or perhaps even to sustain it at today’s levels.

We already have a forecast price-to-earnings (P/E) ratio of 42 for this year, close to three times the long-term FTSE 100 average. But that’s based on current profit streams. Maybe the prospect of SMR profits could be enough to justify it.

Dividends?

Rolls-Royce is looking increasingly like one of the Footsie’s top cash cows. Cash conversion is really quite remarkable. And forecasts indicate net cash by year end of £1.6bn, projected to rise to £6.9bn by 2027.

Why aren’t we seeing any kind of meaningful dividends? We have 4.5p per share at the interim. And if that’s repeated in the second half, it would mean a dividend yield of less than 1%. Forecasts actually put it down at 0.6%.

Shareholders are getting some returns by way of buybacks, mind, with £0.4bn of the planned £1bn for the year now complete. Maybe the board is waiting for the next few years’ predicted growth to slow before they turn to rewarding passive income investors? Or maybe the thought of potential acquisitions might be hovering in their minds? This is pure speculation on my part, but I’d like to see plans for how Rolls will utilise its impressive cash flow in the long term.

What to do?

I’m probably beginning to sound like a stopped clock now. I keep saying the Rolls-Royce share price valuation is too rich for my blood, and I fear a future expectations miss could send it down. And then Rolls makes me look silly by hitting it out of the park again.

But my stance hasn’t changed, though growth investors considering buying even now might well prove me wrong once more.

The post The Rolls-Royce share price surges 10% as H1 smashes expectations. What next? appeared first on The Motley Fool UK.

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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has recommended Rolls-Royce Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.