Stock market

Will going nuclear make Rolls-Royce’s share price even higher?

Image source: Rolls-Royce plc

I have long believed that Rolls Royce (LSE:RR.) share price is expensive.

Analysts are forecasting earnings per share of 15.8p in 2024. This means that the stock currently has a forward price-to-earnings ratio of 29. Compare, for example, RTX, the world’s largest aerospace and defense company. Its stock trades at a multiple of 20.

However, despite my misgivings, investors continue to prove me wrong and drive the share price higher.

Going nuclear.

But there’s a new product line that I think could change the engineering giant’s fortunes.

A small modular reactor (SMR) is a factory-built mini nuclear power station. Each is expected to power one million homes and occupy a site equivalent to two football pitches.

In 2023, the UK government published a plan outlining how it wanted to achieve 24GW of nuclear power generation capacity by 2050.

Under the auspices of Great British Nuclear, a competitive process was launched to select the best SMR technologies to help meet the government’s target.

Six companies, including Rolls-Royce SMR, have been invited to tender and must submit their bids before the end of June.

Size matters.

As well as using SMRs, the government plans to build a large-scale nuclear power station, such as those at Hinckley and Sizewell. But these are plagued by construction delays and cost overruns.

Hinckley Point Sea is now considered the most expensive thing on Earth. When it is finally completed, it is expected to cost £10.03m per MW of capacity.

Rolls-Royce plans to build its own 470MW SMRs at a cost of £1.8bn each. That’s just £3.83 million per MW. I am sure the government will come to its senses soon and abandon its plans for another big power station and focus on a smaller one instead.

If I am correct that means 51 plants will be needed to meet the 24GW target. And potentially £91.8bn in revenue for Rolls-Royce.

At a margin of 20%, this could translate into an additional operating profit of £18.4bn.

It ignores the potential of export markets. And maintenance contracts will generate recurring revenue.

To put these figures into perspective, analysts are expecting group operating profits of £1.95bn in 2024.

Cautious optimism

But I’m not getting too carried away.

The UK’s first SMR is not expected to be operational until the mid-2030s. And their delivery will span a decade or more.

In addition, there is no guarantee that Rolls-Royce will be successful with its bid. The government can also choose several suppliers.

Also, not everyone is convinced that nuclear power is a clean energy source because the waste remains extremely dangerous for thousands of years. The new government may lead to a change in policy and a shift to other methods of energy generation.

Although share prices are considered future-oriented, I doubt that many investors are buying company shares today in anticipation of increased earnings 10 years from now. So it’s a little early to predict how this new technology might affect Rolls-Royce’s share price.

The commercialization of SMRs in the middle of the next decade is a long time to wait. But when the future becomes clearer, I believe the potential of the technology will be factored into the company’s share price.

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