Most brokers are bullish on Rolls-Royce (LSE: RR.) shares right now. However, there’s one that isn’t. Berenberg downgraded the shares to a ‘sell’ rating last week, citing an unfavourable risk/reward setup.
Is selling the right move here? Let’s discuss.
Berenberg’s ‘sell’ rating
In its research note on Rolls-Royce, Berenberg made several interesting points. One was that, for Rolls-Royce to achieve its medium-term profit margin guidance, the company will need to simultaneously improve its pricing structure, reliability, and costs.
The issue here is that history suggests this is easier said than done. In the jet engine business, there can be lots of complications and setbacks.
For example, in November, Rolls-Royce received some criticism from Emirates in relation to the durability of its XWB-97 engines. As a result, the airline pushed back on Rolls-Royce’s maintenance pricing actions.
Another point made by Berenberg was that, after a 220% rally in the shares last year, the valuation discount to the company’s peers has narrowed significantly. This changes the risk/reward proposition.
Berenberg also noted that Rolls-Royce’s not-quite-so-new CEO Tufan Erginbilgiç is often presented in an ‘Elon Musk-like aura’. The broker said that, so far, it has been impressed by the CEO. However, it’s still early days in terms of the company’s transformation programme.
It’s worth pointing out that Berenberg’s share price target for Rolls-Royce is 240p (it lifted its target from 100p to 240p). That implies a potential fall of around 22%.
The right call?
Should investors listen to Berenberg and take their profits here? Well, I do think the broker makes some good points.
For Rolls-Royce to achieve its medium-term guidance (£2.8bn of operating profit versus £0.9bn in 2022), a lot will have to go right.
Meanwhile, after the huge jump in the share price in 2023, the valuation is now quite high. With analysts forecasting earnings per share of 12.6p for 2024, the forward-looking price-to-earnings (P/E) ratio is 24.5. That’s a tech stock-type earnings multiple.
Having said all that, Rolls-Royce shares are in a strong uptrend right now and sentiment is generally very bullish (some brokers have price targets near £4). So, there’s every chance they could continue rising.
What I’d do
I don’t own shares in the engine maker so I’m not in a position to sell them.
However, if I had bought them near their lows (i.e. 70p-£1) and I was sitting on a huge profit right now, I would probably take some money off the table at current levels. That’s generally the prudent thing to do after a massive share price rise.
I don’t think I’d sell my entire holding though. As I said, the trend here is definitely up right now. So, I want to be in a position to capitalise if the shares were to continue moving higher.
