Rolls-Royce shares: where next for the FTSE 100 stalwart?

After what may have seemed like an eternity to long-suffering investors, Rolls-Royce shares have finally sprung into action in 2023. In a move better fitting of the AIM market, the FTSE 100 stalwart is now up 47% year-to-date to 145p — a response to uplifting full-year results and perhaps hopes that new CEO Tufan Erginbilgic will see the aerospace company unlock its full potential.

Rolls-Royce share price: full-year results

FY22 results saw Rolls-Royce deliver an underlying operating profit of £652 million, £238 million higher than the prior year, driven primarily by the civil aerospace and power systems divisions. This was a huge beat compared to the £478 million expected by a Reuters poll of analysts.

The FTSE 100 company also noted its increased new order wins in civil aerospace and defence, leaving it with ‘improved orders, revenue, profit and cash flow in 2022.’ Free cash flow rose to £505 million, £2 billion higher than in 2021 — predominantly driven by a huge recovery in engine flying hours, which rose by 35% year-on-year as the vast majority of pandemic lockdowns subsided.

Further, the company — which earns more on maintenance dependent on hours flown by the engines it makes — expects that engine flying hours will rise to 80-90% of pre-pandemic levels this year.

Meanwhile, net debt fell from £5.2 billion to £3.3 billion due to its long-running disposals program and this increased cash flow. Rolls is now targeting ‘significant performance improvement in 2023 and beyond,’ with underlying operating profit guidance of £0.8-£1.0bn and free cash flow of £0.6-£0.8bn in 2023. A strategic review is now underway to identify priorities, with medium-term financial targets to be set in the second half of 2023.

Erginbilgic enthuses that ‘while our performance improved in 2022, we are capable of much more. Our transformation programme will improve our efficiency and commercial outcomes and deliver a sustainable reduction in working capital.’

It’s likely that a key target will be a return of dividends, while reclaiming its lost investment grade credit rating has already been earmarked as a ‘first priority.’

Where next for Rolls-Royce shares?

Multiple analysts are now bullish on the FTSE 100 company.

Jefferies has a ‘buy’ on the stock and has increased its price target to 170p, saying that ‘the quality of the earnings and free cash flow beat was solid, with lower catch-ups than in H1, and on volumes which remained low... an H2 Capital Markets Day could provide further uplift to estimate by providing a path to mid-teens margin for the group.’

Meanwhile, Deutsche Bank analysts have raised their target price to 160p from 136p, with the team pointing to the second half of 2023 as the next key catalyst.

Bank of America analysts have a price of 175p on the FTSE 100 company, arguing that the turnaround potential is strong as a result both of the new CEO, and of the cyclical benefits of Chinese and international travel reopening. They add that there could be over £1 billion in free cash flow by 2024, leaving the company free to reinstate dividends.

What’s clear is that there will be a change of direction. Erginbilgic — who became CEO on 1 January — is a very different kind of CEO compared to his predecessor and had already likened Rolls to a ‘burning platform’ which had become ‘unsustainable’ prior to the results.

It’s worth noting that there were already 7,000 job cuts made during the pandemic, and the CEO has advised that ‘This is not, “Let’s slash and burn and go.” This is about creating a company that is highly sustainable.’

There are some clues to his priorities. He has called the defence division an ‘enormously good business,’ but thinks that there are improvements to be made concerning the efficiency of civil aerospace operations. Sustainable aviation fuel was also cited as key to Rolls’ net zero goals, while hydrogen fuel cells are now a ‘longer-dated technology potential.’

The promising small modular nuclear reactors could also become a strategic priority, but the company has warned it will run out of cash for the program at current burn rates by the end of 2024. It’s frozen hiring on the team and has warned that it needs the government to ink an agreement, including financial backing, to get the projects off the ground.

This sense of urgency and more encouraging macroeconomic background is certainly encouraging. However, there is still some way to go before the Rolls-Royce share price can approach a return to its pre-pandemic levels.

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