Morgan Stanley ups rating on Rolls Royce on improving cashflow
By Abigail Townsend
Date: Monday 18 Mar 2019
(Sharecast News) - Morgan Stanley has upgraded its rating on engines group Rolls-Royce, arguing that market share gains are likely to drive sector-beating cashflow growth.
The bank, which has moved to 'overweight' from 'equal-weight' with a price target of 1,100p, noted that Rolls-Royce currently trades on average on a 20% discount to peers Safran and MTU on 2020 estimated free cash flow multiples
It said: "We increasingly view Rolls-Royce as mispriced relative to other engine manufacturers.
"Our fundamental argument is that Rolls-Royce is replacing lower quality cashflow with higher quality cashflow over the next several years, and we expect the valuation gap to close as a result.
"We believe there may even be scope for the market to value Rolls-Royce cashflows more highly than its closes peers over the next several years."
In particular, the bank believes Rolls-Royce will increase its share of the widebody installed base to 50% by the early 2020s, driven by "exclusive positions on the A330neo and A350".
It continued: "We forecast 10% compound annual growth rate in Rolls-Royce flying hours over 2017-2022, and 5%-6% CAGR in its installed base of engines. This underpins our forecasts for more than £1bn free cashflow in 2020, and around £1.9bn in the mid-term - we assumed 2024 - in line with company targets."
Morgan Stanley conceded risks remained, however, noting: "We have previously highlight that order cover is shorter, and market traffic growth lower in the widebody segment, though Rolls-Royce's share gains offset some of the concerns."
It also conceded that while the problems surrounding the Trent 1000 engine were now "much improved", further engineering issues on other new engine programmes "cannot be ruled out".
As at 1245 GMT, shares in Rolls-Royce were trading at 901.2p, a 3.6p increase.
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