Could small modular reactors send Rolls-Royce’s share price soaring?

I have long believed that Rolls Royce Resources (LSE:RR.) share price will be high. This seems to reflect the company’s expected earnings growth, which has not yet been delivered.

A summary of broker forecasts on the company’s website shows expected earnings per share (EPS) for the year ending December 31, 2027 (FY27) of 25.9p. At the current (September 20) share price of 525p, this implies a forward price-to-earnings (P/E) ratio of 20.2.

I think this is a pretty reasonable solution for an engineering and technology group.

But there’s still a long way to go. The company reported EPS of 13.75p for FY23. That’s why its current P/E ratio is a staggering 38.2.

A 62% profit increase over three years is an ambitious goal. But I wouldn’t be surprised if the group achieved it. The company’s recovery from the pandemic — when it had to raise billions to survive — has been extraordinary.

Dare to be different

By 2027, we will likely know whether the company’s diversification into small modular reactors (SMRs) — nuclear power plants built in factories — will prove successful.

While the first of these are unlikely to be operational until 2030, we should have enough orders or expressions of interest within three years – and a few successful prototypes built – to find out whether SMRs can help continue Rolls-Royce’s development story.

Personally, I think they can have a big impact.

We are going nuclear

According to the International Atomic Energy Agency, by 2025 the installed base of nuclear power plants could increase from 371 GW to 890 GW.

Since electricity demand is now growing at twice the rate of total energy, the extra power has to come from somewhere. And SMRs are likely to play a large role in the world’s future energy production.

That’s because larger conventional power stations have gone out of fashion. Their reputation for huge cost overruns means operators are looking for cheaper, quicker-to-build alternatives. When Hinkley Point C (Somerset) is completed, it is expected to be £34bn over budget.

A huge opportunity

The additional 519 GW of nuclear power is equivalent to more than 1,500 small miniature reactors.

At an estimated retail price of $1 billion per unit, this is a potentially huge market. And Rolls-Royce could benefit enormously from it. If all goes according to plan, it will not only be able to make money on the units themselves, but also generate revenue from maintenance contracts, spare parts and operating agreements.

Of course, the technology has yet to be proven. And there are other well-funded competitors. They include a Wyoming-based project backed by Warren Buffett and Bill Gates.

Besides, I don’t think it makes sense to buy stocks today in the hope that a new market will emerge in six years. That said, that’s the time frame some investors consider when investing in startups before they hit revenue.

But unlike a recently formed company trying to develop new technology, Rolls-Royce has the advantage of being 118 years old. Its traditional business can provide the cash needed to develop a nuclear program.

But back to my original point. Based on what I know today, the stock seems expensive to me. However, I will be watching with interest how the company handles its SMRs. The stock price could start to rise rapidly if everything works out.