Rolls-Royce’s Best Month Since November Sparks Recovery Optimism

(Bloomberg) --

Rolls-Royce Holdings Plc is making steps toward recovery and the market is noticing. The stock is on track for its best month since November, buoyed by the easing of U.S. travel restrictions, asset sales and a major engine contract.

The U.K. jet-engine maker is also one of the biggest gainers in the benchmark Stoxx Europe 600 index in September, with a 24% advance so far, though the shares still languish below the heights reached before the coronavirus pandemic ravaged the travel industry.

“It’s been a pretty rocky ride with Rolls-Royce in recent years,” Stephen Payne, a portfolio manager at Janus Henderson Investors, said in an interview. “Taking a longer-term view, one can see why there’s potential scope for recovery to start coming through there.”

Analysts at JPMorgan and Vertical Research Partners increased their price targets on the stock this week as the company strives to repair its balance sheet and restore an investment-grade credit rating. It gained a contract to provide upgraded engines for the Air Force’s aging B-52 bomber in an award that could grow to $2.6 billion, the Pentagon said Friday. And on Monday, Rolls-Royce agreed to sell its ITP Aero unit for 1.7 billion euros ($2 billion).

“Confirming the deal is an undoubted positive,” JPMorgan analyst David Perry wrote in a note Monday, adding that the transaction would meaningfully reduce Rolls-Royce’s headline gearing. Meanwhile, the reopening of U.S. borders to most fully vaccinated travelers, a decrease in global Covid-19 cases and improving inoculation rates in Asia “should result in stronger engine flying hours,” he said, bringing in crucial maintenance revenue next year.

The London-based company was hit particularly hard by the pandemic as it powers large jets and travel demand isn’t expected to recover to previous levels for years.

Although the shares still trade more than two-thirds below their peak in January 2014, some analysts and investors remain cautious. Janus Henderson’s Payne, who doesn’t own the stock, wants to see more tangible cash-flow delivery before turning more positive. 

Meanwhile, Vertical Research Partners analyst Robert Stallard called the stock’s valuation “eye-watering” following its recent advance. Rolls-Royce trades at about 36 times analysts’ profit estimates for the next 12 months, compared with an average price-earnings ratio of 21 times for the Stoxx 600 Industrial Goods and Services Index.

“While these three news items are all positive for Rolls-Royce, it remains in our view one of the riskier names in the aerospace sector,” Stallard said in a note Tuesday.

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