Interactive Investor

New Rolls target revealed as bull run continues

The surge in Rolls-Royce valuation means the ink is barely dry on City target prices before they get renewed. What does this bank think the shares are worth?

21st March 2024 13:53

Graeme Evans from interactive investor

Increased confidence in the Rolls-Royce Holdings (LSE:RR.) turnaround story today prompted a City bank to set its sights on a further big upside for shares to a new price target of 550p.

The upgrade by UBS is its fourth since July as analysts at the firm keep pace with the momentum that’s seen Rolls rise another 39% in 2024 on top of last year’s 221% jump.

Today’s sweetened “Buy” rating, which followed Tuesday’s upgrade by US bank Jefferies to 470p, helped the engines maker up another 8.9p to 415.6p in a strong FTSE 100 index.

The continued support of UBS follows February’s annual results, which showed the early  benefit of efforts by new chief executive Tufan Erginbilgic to improve efficiency, reduce costs and enhance the company’s pricing position.

UBS said: “We have increasing confidence in the Rolls-Royce turnaround story after fourth-quarter results and accompanying management interactions and so increase our price target to 550p, from 400p previously.”

In the largest division of civil aerospace, Rolls posted an improved operating profit and a four-fold margin increase despite engine flying hours only 88% of pre-pandemic levels. This was driven by increased aftermarket profit.

Among Erginbilgic’s medium-term targets are to quadruple operating profit from the 2022 baseline to £2.5 billion-£2.8 billion and for an operating margin at least as competitive as peers. He is also looking to grow sustainable cash flows to between £2.8 billion-£3.1 billion..

However, he said in the annual report that these mid-term targets are merely milestones and not the final destination: “Rolls-Royce will continue to grow with enhanced margins and cash flow well into the long term as a result of our strategy and the choices we are making today. 

UBS said today that 2024’s and, to a lesser extent, the mid-term earnings guidance for 2027 looks conservative, given the recent margin improvement and optimism on engine flying hours.

It models £3.3 billion free cash flow in 2027 although it admits that investors will first need firmer evidence of execution, especially on cost reduction and price increase efforts, before pricing this target in. 

The 550p figure is equivalent to a 5% 2025 free cash flow yield, still a big discount to peer Safran. It said the continued valuation gap showed investors still unwilling to fully price the improvement programme given Rolls-Royce's historical execution challenges.

Rolls is expected to return to an investment grade profile during this year, which opens the door for the resumption of dividend payments by 2025.

Last month, Bank of America highlighted a further re-rating opportunity after raising its price target to 520p amid growing conviction in management's mid-term targets.

In particular, it highlighted strong margin execution in both Defence & Power Systems as well as solid margins with better quality in civil aerospace.

Graeme Evans owns shares in Rolls-Royce.

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