Is Rolls-Royce stock now a screaming buy?

Rolls-Royce (LSE: RR) shares have been on fire in the last few months. In fact, since its low in October last year, the stock has doubled. It’s up more than 50% in 2023 alone, as investors have become bullish about the engine maker’s potential turnaround.

However, over five years, the stock is still down 51%. So what’s the screaming buy for me today at 154p?

Support full year results

Rolls-Royce engines power some of the biggest jets in the sky. So when the pandemic takes its toll on the global civil aviation industry, the engineering giant could collapse. In order to survive, the company is forced to create a balance sheet with new amounts of equity and debt.

However, there are some encouraging signs in last year’s results. Net debt was reduced by almost £2 billion during the year, to 3.3 billion. It should be noted, though, that this red is mainly sent through the cash raised from the disposal of assets.

Free cash flow from operations continues to increase to £500m in 2022, from an outflow of £1.5bn in 2021. This is helped by 35% growth in large engine flying hours.

Going forward, the reopening of Chinese airline flights is obviously big for Rolls-Royce. China represented about a quarter of engine flight hours in 2019 before Covid. The company is paid by the hours its engines are in the air, so the fact that it now expects flight hours to return to 80%-90% of pre-pandemic levels this year is encouraging.

A new direction

Tufan Erginbilgic became the new chief executive of Rolls-Royce earlier this year. Before joining the engine manufacturer, he spent 20 years in executive roles at BP. There, they help reduce costs and increase revenue. In fact, Barclays once described BP’s struggling downstream operations as “Tufantastic“.

He is committed to return Rolls to an investment-grade credit rating, which will continue to pay dividends. A large part of this will involve continuing to improve the balance sheet.

However, significantly reducing corporate debt from here will be more challenging. There are only so many assets that can be sold.

The future is still uncertain

The company is developing many green technologies that are still unproven such as electric, hybrid and hydrogen propulsion. Then there is the small modular nuclear reactor (SMR) business. Will it continue to invest – and potentially continue to lose – money in this long-term project?

I really need to position myself for a net-zero world beyond fossil fuels. But unlike BP, which is investing billions in future green projects, the engine maker is doing so from a weaker financial position.

For example, Rolls-Royce says its £500m SMR program will run out of cash by the end of 2024. What will happen if the government doesn’t bail it out or subsidize it?

Erginbilgic is known for setting a very clear operational direction. So I’m sure investors will find out sooner rather than later.

In the meantime, I’ll keep the stock on my watchlist, especially after its recent explosive rise. There is so much uncertainty at the moment that I call this a screaming buy.