Interactive Investor

Rolls-Royce shares are now a sell, argues City dissenter

A brave analyst has stuck their head above the parapet and downgraded their rating on the aero engineer. City writer Graeme Evans runs through the rationale.

16th January 2024 16:28

Graeme Evans from interactive investor

A “sell” recommendation on Rolls-Royce Holdings (LSE:RR.) today by one team of analysts blotted the City’s bullish view that shares have further to go following last year’s three-fold jump in valuation.

Berenberg’s caution and new 240p price target took more steam out of shares at the start of 2024, with the FTSE 100-listed engines giant dropping 2.5% at the start of trading Tuesday.  

The bank warned that history suggests Rolls may find it difficult to deliver simultaneous improvements in pricing, cost and reliability in order to achieve medium-term guidance.

Its analysts said: "Pricing, the most important factor for intrinsic valuation will be a challenge, given current reliability issues for key engines, which serve an airline industry that typically operates on low margins and appears to be approaching peak earnings."

While the bank has been impressed by Tufan Erginbilgic’s first year in charge at Rolls and endorses his strategic philosophy, it points out that it is still early days in terms of the execution.

Berenberg’s commentary counters at least 14 “Buy” or “Strong Buy” recommendations for Rolls, with UBS and Deutsche Bank among those backing the shares to reach 400p. According to financial market data firm Refinitiv, there are four “hold” ratings and just the one “sell”.

Their upgrades followed the company’s capital market day, when Erginbilgic's target for 2027 free cash flow of £2.8 billion-£3.1 billion was some 30% higher than the City consensus.

Rolls is expected to resume dividends this year once it regains an investment grade rating, with Bank of America also seeing £2.2 billion and £3.7 billion of share buybacks in 2026 and 2027. 

Retail investors also remain largely supportive as the Derby-based company was the third most traded stock on the interactive investor platform this morning, two-thirds of which were “buy” orders. And by late afternoon, Rolls shares had clawed back early losses to trade just a fraction lower than where they’d started the day. 

City analysts cast a critical gaze over several other stocks in the FTSE 100 today, leading to big downward share price movements for AstraZeneca (LSE:AZN) and Rightmove (LSE:RMV).

The drugs giant fell 298p to 10,554p after UBS flagged the impact of US healthcare reform on the revenues outlook for key products Tagrisso, Lynparza and Calquence by 2026.

The bank also assumes lower margins than the City expects due to accelerating research and development costs, leading to core earnings 5% below estimates in 2025-26. It sees limited upside for shares, meaning a “Sell” rating and 10,700p target price.

The bank prefers GSK (LSE:GSK), which it has switched to a “Buy” stance with much-improved target price of 1,860p. It sits 5% above the consensus for 2028 sales estimates, aided by optimism over the long-term China opportunity for shingles vaccine Shingrix.

It added: “The key driver of our higher margin assumptions is the improved gross margin from the mix shift away from older, lower-price-point primary care-focused general medicines towards more specialty drugs and adult vaccines. 

Rightmove shares were the biggest faller in today’s FTSE 100 session, down 26.6p to 538.2p after JPMorgan revealed an “underweight” stance and 493p target on the property portal.

Rentokil Initial (LSE:RTO) also fell 3.6p to 416p after UBS reiterated a “Sell” position and 375p estimate.

Shares have fallen 30% since the company’s third quarter warning of tougher conditions in the North American pest control market. The bank warns of further risk for investors as Rentokil’s integration of newly-acquired Terminix moves into the “heavy-lifting” stage. 

The bank sits 5-10% below consensus profit forecasts for 2024-25: “While valuation looks cheap relative to history we believe a larger discount could be merited for this period of greater earnings risk and lower earnings quality.”

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