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Few UK stocks have enjoyed the stellar run Rolls-Royce (LSE:RR.) shares have delivered in the last five years. Following a drastic change in strategy under the leadership of Tufan Erginbilgiç, the engineering giant quickly went from barely staying afloat to an operationally revamped money-printing machine.
Non-core operations were disposed of, debt was restructured, and cost-saving initiatives enabled profit margins to expand, all being executed at a much faster rate than initial anticipated. At the same time, the company was riding the tailwinds of a recovering aviation industry. And five years on, we now see the results.
Operating income has gone from a loss of £1.98bn in 2020 to a profit of £2.9bn as of December 2024 – a £4.9bn improvement. But more impressively, free cash flow generation has exploded from £4.18bn in the red to £2.4bn in the black – a £6.6bn increase.
Needless to say, it’s a remarkable turnaround. And so it should hardly be a surprise that Rolls-Royce shares have since increased by a jaw-dropping 953%. To put this into perspective, a £1,000 investment in July 2020 is now worth £10,530!
What’s next?
Despite having such enormous growth under its belt, the outlook for Rolls-Royce shares remains promising. Management’s raised its guidance for operating profits in 2025, with operating margins on track to overtake industry peers. As such, the firm’s on track to hit its 2027 goals almost two years ahead of schedule.
The travel market’s now largely back on its feet. As such, the aviation tailwinds have started to soften. Yet, this impact’s being offset by renewed demand in its Defence and Power Systems segments. A new £9bn submarine reactor contract has pushed the defence order book to record highs. And at the same time, infrastructure upgrades at the datacentre are ramping up demand for the firm’s mtu emergency power generators.
With that in mind, it doesn’t seem likely growth will slow quite yet. However, despite the continued progress, there are still a few weak spots investors must consider.
Not all cracks are fixed
Progress in the Defence and Power Systems divisions is encouraging to see. But the company’s still largely dependent on its Civil Aerospace segment, which is sensitive to external factors such as economic shocks. And with US tariffs looming over the world, the near-term outlook for the travel market’s getting muddier.
Even if tariffs don’t prove as disruptive as expected, there’s still the question of Rolls-Royce’s long-term growth engines. A lot of money is being invested in its small modular reactors initiative. Yet the technology, while potentially transformative, ultimately remains unproven. And when pairing this uncertainty with a price-to-earnings ratio of 32, it opens the door to significant volatility if Rolls-Royce fails to deliver.
The bottom line
While Rolls-Royce has its fair share of challenges on the horizon, Erginbilgiç’s proven he knows how to navigate through a storm. And even if growth suffers in the near term, its newly-established free cash flow-generating capabilities give management a lot of financial flexibility that didn’t exist before. That’s why I think Rolls-Royce shares are worthy of closer inspection.
