The Rolls Royce (LSE:RR) share price has the FTSE100 and the overall market by some distance over the past 18 months. It’s a turnaround that deserves all the attention it’s getting.
However, the Labour government, which came to power with an overwhelming majority in early June, offers the British engineering giant new opportunities, but also potential obstacles.
So let’s look at three ways Labour could influence Rolls-Royce.
Defense spending
Defence is Rolls-Royce’s second-largest business, accounting for around 25% of sales. Not surprisingly, this business is currently doing quite well, with Russian hostility and Chinese assertiveness leading to new Western commitments to defence spending.
Rolls-Royce does not sell weapons and ammunition, but supplies the powertrain for military vehicles. As a result, the company benefits from government support for long-term programs such as AUKUS and Tempest, rather than from supplying ammunition, as some of its competitors in the defense sector do.
As for Labour, the government has committed to increasing the UK’s defence spending to 2.5 per cent. While there is no timetable for this yet, Labour says it will happen faster than it would have under the Conservatives. This could be a boost for Rolls, but that remains to be seen.
Small modular reactors
Rolls-Royce is one of a handful of companies shortlisted to manufacture Small Modular Reactors (SMRs), part of a larger plan to increase nuclear power capacity to 24 GW by 2050.
It is unclear what approach the Labour Party will take on SMR, but Rolls-Royce appears to be the frontrunner in this process.
Currently, SMRs fall under a business segment called ‘New Markets’ and the company has received some development grants worth £18 million and could receive a further £215 million in the second phase of the programme.
Although a final investment decision is unlikely to be made until the end of the decade, this area could account for a significant part of the business from the 2030s onwards and, in my opinion, generate billions in revenue from installment payments and services.
Union problems
Union activities are not uncommon at Rolls-Royce. Quite the opposite. The engineering giant has already lost thousands of working hours to strikes this year. Most recently, workers on the nuclear submarine program went on strike for a month because the company did not present an acceptable wage increase.
Labour, with its roots in the trade union movement, comes to power on a promise to negotiate a new deal for workers’ rights. This could tip the balance of power back in favour of the unions and put pressure on Rolls’ current pay structure and potentially profitability per worker.
It is important to point out, however, that more harmonious relations between trade unions and companies, if this can be achieved, would most likely be desirable.
The conclusion
Labour could bring both challenges and opportunities for Rolls-Royce, but it is certainly worth noting that at a price-to-earnings ratio of 28, some analysts will argue that the company is priced perfectly.
Although I personally still consider the stock to be undervalued with a price-earnings-growth (PEG) ratio of 1.03, I accept that its inflated short-term metrics make it more vulnerable to surprises.
The post “Three ways Labour could affect Rolls-Royce’s share price” first appeared on The Motley Fool UK.
Further reading
James Fox holds positions in Rolls-Royce Plc. The Motley Fool UK has recommended Rolls-Royce Plc. The views expressed on companies mentioned in this article are those of the author and may therefore 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.
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