Analysts at Bank of America hiked their target price for shares of Rolls Royce from 55.0p to 80.0p in anticipation of stronger than previously expected free cash flow generation in 2022.
However, they kept their recommendation for the shares at ‘underperform’.
Projections for “strong” outcomes in the firm’s Power Systems and ITP units are what led BofA to raise its FCF forecast for 2022 to £364m.
Driving their expected recovery in growth in Power Systems was short-cycle demand in China, with margins in the unit seen rising past 10% by 2022 and into the mid-teens thereafter.
Key to their thinking, the debate around the engineer had shifted from its balance sheet towards its ability to meet its FCF guidance for 2022-23 of £750m.
Admittedly, balance sheet concerns had reduced and liquidity bolstered, “but the longer term target of net cash depends heavily on the disposals, which we see as binary,” the analysts cautioned.
Yet the now higher FCF multiple of 14 times led them to revise their target price higher.
On the flip side, their new target was still at a 45% discount versus peers’ Safran/MTU’s FCF multiple, versus 50% before.
Given the recovery risks to widebody aircraft demand, the estimated 2023 7.7% FCF yield on offer was not attractive, hence their decision to stay at ‘underperform’.
To take note of, whereas Rolls Royce was anticipating a recovery in flight hours to 80% of their 2019 level, down from previous guidance for a 90% recovery, BofA was only expecting a recovery to 70%.
BofA added: “We are a strong believer in the traffic recovery this summer, but see this focused on leisure.”
“Defence sales growth is expected to stabilise through to 2022 reflecting a flattening defence budget environment in the aftermath of COVID-19, echoing commentary from BAE Systems.”
