Interactive Investor

Rolls-Royce shares: here’s why they just surged to a four-year high

The turnaround at this iconic jet engine manufacturer has surprised most in the City and beyond, and now the boss is betting his team will do even better. It could mean dividends for loyal shareholders sooner than expected.

28th November 2023 13:45

Graeme Evans from interactive investor

An upbeat Rolls-Royce Holdings (LSE:RR.) today fuelled its remarkable share price turnaround by unveiling medium-term targets stronger than even the most optimistic City forecasts.

The new guidance helped Rolls shares trade at a fresh four-year high of 261.6p, up from 100p when chief executive Tufan Erginbilgic took the helm at the start of this year.

He told a gathering of key investors and analysts that his “compelling and achievable” financial targets will take Rolls-Royce significantly beyond any previous financial performance. This includes operating profits of between £2.5 billion and £2.8 billion.

The former BP executive added: “This will benefit not just our shareholders but our people, customers and partners.”

The standout metric looks to be his 2027 free cash flow target of £2.8-£3.1 billion, which is 30% above the City consensus. This compares with £505 million generated in 2022 and the company’s unchanged forecast for 2023 of between £900 million and £1 billion.

The overall margin target of 13-15% is also about 100 basis points above the midpoint of the City consensus, with estimates for all three divisions ahead of expectations.

The largest operation of civil aerospace is backed for between 15% and 17%, a big jump from 2022’s 2.5% but still short of the 20% plus achieved by aero engine peers GE and Safran.

The company has identified six levers for improving widebody margins, while it is also looking to re-enter the more profitable narrowbody market through a partnership approach for its next new engine programme.

The power systems margin of 12-14% is broadly in line with peers, while Morgan Stanley said that the defence arm’s projected 14-16% appeared to be particularly strong.

The only minor disappointment for the City bank was the lack of upgrade to 2023 guidance, given that engine flying hours are near the top end of City hopes at 86% of 2019 levels.

The bank added: “Overall, it is clear that there remains considerable further upside under management's medium-term plan, which appears focussed, structured and deliverable.”

Erginbilgic and his top team set out the details behind the strategy and targets at a series of presentations due to last four hours this afternoon.

He said this morning: “Rolls-Royce is at a pivotal point in its history. After a strong start to our transformation programme, we are today laying out a clear vision for the journey we need to take and the areas where we must focus.”

The plans include £1 billion and £1.5 billion of disposals over the next five years as Rolls builds a balance sheet worthy of an investment grade profile in the near term.

Many City analysts are expecting that this will mean the return of dividend payments from next year — a significant landmark for a company that in November 2020 offered existing investors the opportunity to buy shares at 32p in a £2 billion rights issue.​​​​​​​

In response to today’s presentations, UBS said the company’s new medium-term targets looked to be slightly above its own bullish view.

The Swiss bank recently flagged an upside scenario where the shares reached 600p, with its base case at 350p built on targets materially stronger than City forecasts.

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