Rolls-Royce Shares: Assessing Momentum Amid a Lofty Valuation

Rolls-Royce GB00B63H8491

A multi-year transformation has repositioned Rolls-Royce from a corporate laggard to a beneficiary of several powerful trends. The company is now capitalizing on rising defense budgets, resilient demand for large aircraft engines, and the fruits of a sweeping efficiency drive. Recent developments, including a major military engine order, a nearly completed share buyback, and a credit rating upgrade, add to this momentum. The central question for investors is whether the current premium share price is justified by these fundamentals.

Management's efforts to bolster the balance sheet and shareholder returns are progressing. A £1 billion share repurchase program announced in February 2025 was approximately 90% complete by mid-November. This marks the first capital return to owners since the pandemic, signaling confidence in the company's sustained earnings power.

The financial profile has improved markedly. In late November, Moody's upgraded the long-term credit rating to Baa1 from Baa2, assigning a positive outlook. The agency cited the strong operational performance, successful turnaround, and a net cash position. Available liquidity stands at roughly £8.3 billion, comprising £5.8 billion in cash and an undrawn £2.5 billion credit facility. This stronger footing typically reduces financing costs and provides greater flexibility for future investments, research, or further shareholder distributions—a key point watched by institutional investors.

Major Defense Contract Provides Visibility

A significant new order for the Power Systems division underscores one pillar of growth. The unit will supply over 300 mtu MB 873 Ka‑501 engines for new Leopard‑2 battle tanks produced by defense contractor KNDS. The company describes this as one of its largest contracts of this kind in decades.

The engines are destined for several European NATO members, including Germany, Lithuania, Sweden, the Netherlands, and the Czech Republic. Deliveries are scheduled to commence in 2026, providing a pipeline of predictable revenue for the coming years. Rolls-Royce highlights the geopolitical dimension, noting the order reflects the tense security situation in Europe and the growing importance of government clients. Government contracts already accounted for about a quarter of the Power Systems division's revenue last fiscal year—a share that gains further weight with deals of this magnitude.

Operational Performance Confirms Turnaround

A November trading update confirmed Rolls-Royce's guidance for 2025. The group anticipates an underlying operating profit of £3.1 to £3.2 billion and a free cash flow of £3.0 to £3.1 billion. This maintains a clear focus on profitability and cash generation following years of restructuring.

Key operational drivers include:

• Civil Aerospace: Demand for large engines remains sturdy. In the second half of 2025, the company secured significant orders from IndiGo, Malaysia Airlines, and lessor Avolon. The Airbus A350F freighter, powered by Trent XWB‑97 engines, is garnering increasing interest, particularly in China and the Asia-Pacific region.
• Defence: The division benefits from elevated defense spending among NATO allies. In October, Turkey and the UK agreed on the delivery of 20 Eurofighter Typhoon jets, which use EJ200 engines from Rolls-Royce.
• Power Systems: Beyond the Leopard tank contract, high demand from data centers and additional government agreements are driving order intake and revenue. The unit is also expanding its portfolio of propulsion systems for military land vehicles.
• Small Modular Reactors (SMR): In the nuclear segment, Rolls-Royce SMR has advanced to the final stage of technology selection in Sweden. In the UK, commercial terms with Great British Energy‑Nuclear are expected to be finalized by year-end as planned—a potential gateway for future growth.

This blend of high utilization in the core business, new defense orders, and long-term projects like SMR supports the current earnings momentum.

Analyst Consensus Points to Further Gains

Despite a modest pullback last month, analyst sentiment remains predominantly positive. Several major banks have recently updated their models without altering the constructive overall tone.

• JP Morgan sets a price target of 1,320 pence, advising clients not to overinterpret recent share price weakness, citing the still-strong fundamental position.
• Morgan Stanley sees a fair value of 1,280 pence.
• Citi is more cautious at 1,101 pence, roughly aligning with recent price levels.
• RBC Capital Markets initiated coverage in November with an "Outperform" rating and a £12.75 target. Their analysts argue that the portfolio of large civil aviation engines alone could justify approximately 70% of the current market capitalization.

The average price target derived from these estimates is around 1,242 pence, implying an upside potential of roughly 13% over the next 12 months. Eighteen analysts cover the stock, with a consensus "Buy" recommendation.

Valuation Commands a Significant Premium

The share price appreciation of recent years has lifted the valuation substantially. Since the start of the year, the stock is up approximately 76% in Euro terms. It traded at €12.56 on Friday, about 10% below its 52-week high but nearly 89% above its low at the beginning of the year.

Based on current estimates, Rolls-Royce shares trade at a forward price-to-earnings (P/E) ratio of approximately 35.7—significantly above its own ten-year average of around 17.4. The current P/E ratio of about 15.8 to 16.7 reflects the earnings leverage already achieved through the transformation program.

The market is thus paying a noticeable premium for expectations of further growth, high cash flows, and a durable turnaround. Consequently, the buffer for operational setbacks has narrowed: disruptions in supply chains, shortages of specialized components, or delays in major projects could now impact the share price more swiftly than in the past.

Outlook: Key Tests Lie Ahead

The immediate focus is on two upcoming milestones: the finalization of SMR terms with Great British Energy‑Nuclear by year-end, and the full-year 2025 results, scheduled for release in late February 2026. These events will reveal whether Rolls-Royce can meet or exceed the high current expectations for revenue, margins, and cash flow.

The transformation initiated under CEO Tufan Erginbilgiç, who initially described the company as a "burning platform," has so far delivered markedly improved metrics and a stronger financial foundation. Facing elevated European defense spending, solid civil aerospace demand, and progress in SMR, Rolls-Royce enters 2026 from a position of strength—albeit with a valuation that makes consistent execution an imperative.