Rolls-Royce share price keeps rising as guidance still conservative

Another turbocharged Rolls-Royce Holdings (LSE:RR.) share price performance today added fuel to the debate over whether the engine giant really has the potential to hit 600p.

The latest cheer for investors who bought shares before July’s big upgrade to profit guidance came as Rolls peaked at 223p, a 6p increase in today’s lacklustre FTSE 100 session.

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The stock was 152p just over a month ago and 80p at the time of August 2022 results.

Plenty of ii customers have enjoyed the turnaround ride under new boss Tufan Erginbilgic, whose progress is being aided by airline industry tailwinds as engine flying hours recover.

Despite recent momentum, most of this morning’s orders on the interactive investor platform have been to buy shares as Rolls continues to rank among ii’s most traded stocks.

Source: Trading View. Past performance is no guide to future performance.

The interest has been fuelled by a flurry of broker upgrades suggesting there’s further to go as Erginbilgic continues to pick off low-hanging fruit in the restructuring drive.

By far the most bullish of the City firms is UBS, which last week fired up interest in Rolls shares by lifting its “base case” price target by 175% to 350p.

In its upside scenario, where Rolls delivers 2026 margins on a par with industry peer Safran, UBS sees fair value at 600p. Noting that the risks and rewards are high, the downside scenario is 100p if the recent improvements prove to be unsustainable.

UBS stuck by its estimates in a follow up note published on Tuesday: “Feedback on our Rolls-Royce price target upgrade to 350p suggests we are towards the top end of investor expectations on free cash flow, ahead even of some bulls. We remain comfortable with our estimates.”

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The bank’s modelling points to civil aerospace engine margins of 15% in 2028, which is still well below Safran at 18-20% and MTU's OEM business at 20-22%,

The overall Rolls operating margin stood at 9.7% in this month’s results, up from 2.4% the year before due to higher volumes, commercial improvements and cost efficiencies. In civil aerospace, the margin hit 12.4% from a negative 3.4% previously.

Erginbilgic’s plans for addressing the shortfall to peers will be revealed on 28 November when he presents a strategy review along with medium-term goals for the business.

In the short term, Rolls expects an operating profit in 2023 between £1.2 billion and £1.4 billion and free cash flow in the range of £900 million and £1 billion. However, UBS thinks this recently-upgraded guidance still looks conservative given the strength of first half results and historic seasonality patterns.

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It estimates that Rolls could achieve £2 billion of free cash flow as soon as 2024, potentially rising to £2.8 billion in 2026. The analysis points to favourable recent trends where Rolls may already be generating around $380 per flying hour on average against $300 in 2019.

The bank added: “A new CEO combined with a strong and under-appreciated market tailwind coming from China is likely to drive continued upside throughout 2023.”

Among other City firms, Bank of America recently increased its price target from 190p to 260p. It sees the potential for a return of dividend payments in the 2024 financial year as the balance sheet has become less of a concern for investors.