The Rolls-Royce (LSE:RR) share price has been rising this week after the company announced its 2023 results. It’s no secret that the last year has been a strong one, but the market was impressed.
The stock is up almost 170% over the last 12 months. But the thing is, it looks to me like there might well be further for this one to run.
Results
At first sight, the numbers for Rolls-Royce look impressive. Revenues increased by 22% to £16.49bn, underlying operating profit went up 130% to £1.59bn, and free cash flows came in at £1.3bn.
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That’s coming off a base that’s somewhat depressed by lasting Covid-19 implications. But in terms of revenue, the recovery seems complete – £16.49bn puts the business back at pre-pandemic levels.
Rolls-Royce revenue 2014-24
Created at TradingView
Importantly, management is forecasting more to come. The company’s guidance for 2024 is for operating profits to be between £1.7bn and £2bn, with free cash flows between £1.7bn and £1.9bn.
That would imply increases of around 10% in operating income and 38% in free cash flows. That’s slower than 2023’s growth, but it still represents strong progress.
Promising or disappointing?
Rolls-Royce had previously stated that its ambition over the medium term is for £2.8bn-£3.1bn in free cash flow. So I think it’s best to view 2023’s results as a checkpoint on the way to this.
According to UBS, the forward guidance might disappoint some parts of the market. While the free cash flow growth is substantial, it’s short of the £2bn investors might have been expecting.
Analysts at J.P. Morgan take a different view, though. They’ve recently increased their price target from 400p to 475p, which is 33% above the current share price.
I’m in the camp that views the result positively. As I see it, the market’s reaction to the earnings report is about right, both in terms of the current performance and the forward guidance.
Investment thesis
Over the medium term, Rolls-Royce is guiding for £2.8bn and £3.1bn in free cash flows per year. At those levels, a £30bn market cap – implied by the current share price looks like a bargain.
The question is whether or not the business can achieve this. I think it can and the results from 2023 indicate that the company is on the right path.
Rolls-Royce total debt 2014-24
Created at TradingView
The company’s total debt is still higher than it was in 2019. I expect this to reduce over time and have a positive effect on Rolls-Royce’s operating profits and free cash flows.
Military spending is high and travel demand is strong, but both of these are highly cyclical. Over the long term, I think the way for the firm to grow is by improving its balance sheet to bring down costs.
A stock to consider buying?
Over the last year, Rolls-Royce has made some impressive progress. And its shares have come closer to a level that reflects that.
As more and more of the company’s free cash flow ambitions come to be reflected in the Rolls-Royce share price, the discount to intrinsic value decreases. That’s why I’m looking elsewhere right now.
