Rolls-Royce set to see a tripling in its shares?

(Video Transcript)

Rolls-Royce shares shine

The FTSE 100 listed aero engineering company, Rolls-Royce, had a boost this morning. It received a positive note from analysts at the Swiss bank, UBS. I'll take a look at levels in just a minute, but the background to this is that Rolls-Royce has been beaten up over the last few years, some of which have come during COVID.

Rolls-Royce manufactures engines, but a large part of its business is the servicing of those engines. And the more time that aircraft spend in the air, the more servicing contracts that come into effect and Rolls-Royce makes money out of that. It's also got other engineering projects under way and we've seen a new chief executive in the last year or so, and this has done a world of difference for the share price as well.

Hit by the impact of COVID

I want to take a look at the share price before I take a look at the analysts' notes, just to see exactly where we've come from. As I said, Rolls-Royce, these heights go all the way back to August 2018 when the stock was over £10 a share. Then came all sorts of problems. Warren Rees found it difficult to make any headway and the stock was bumping along the bottom for a considerable amount of time in the wake of the COVID lockdowns.

Now, since the lows that we had back in September last year, there have been some great strides on the upside. And, in fact, this blue box here is from the beginning of this year to the last couple of weeks where the stock was up 127.25%. Now, that's more than doubling in its share price that you can see.

And interestingly enough, we are at the moment very close to breaking this gap that we had here that opened up in the shares back in October 2020. Technically, closing a gap is very important and we are very close there. That black line there takes us up to the levels of 218 pence. We're currently trading at 205.9. But to today's note, more detail, you can see the uplift we've seen in shares in today's trade.

Firm could face serious headwinds

UBS says we believe that 2023 guidance looks conservative, that Rolls-Royce could achieve some £2 billion worth of free cash flow as soon as 2024, and £2.8 billion of underlying free cash flow by 2026. However, there are some serious macro headwinds with all this, I think, that the company may face.

China, for one, is where Rolls-Royce is heavily exposed. But in the face of this, UBS says the aero engine service business may be bolstered by increased flying hours and its clients running RR technology. So now, where do shares go? Well, there are two situations or scenarios, if you like. I hate that word. But there are two scenarios that are set up by the analysts at UBS.

One is that we see a near tripling of the share price up from £2, all the way up to this red-dotted line here, £6 a share, which will then take us past this little gap as well, all the way up to levels not seen since March 2020, when the company started having all those problems. And the business has got to go great guns before it gets there.

No returns without risks

But as I said, the macro headwinds are also among the risks that the analysts talk about. And they're saying the downside risk is this red line down here, which is £1 a share, a nice round number. But that would take us in back to levels not seen since 9 January. So you basically pay your money, you take your choice and you look at the opportunities here for Rolls-Royce.

But certainly UBS sees a lot of upside and a lot of activity that's not yet priced into the stock price of Rolls-Royce. But a tripling from here to £6 seems to me to be a little bit rich. But nonetheless, sometimes you've got to take a risk in order to get those returns. Even if it's only part of the way there, up to £4, that would then take us back to levels not seen since June 2020. And that would be a big improvement from where we are in Rolls-Royce shares.