I was a little surprised to see the Rolls-Royce (LSE: RR) share price jump 6% when it released its half-year report on Thursday. I’ve been bullish on the stock, but the report knocked one of the planks of my investment thesis.
Here, I’ll discuss the element that disappointed me, and the positives in the results. Weighing them up, would I still buy the stock today?
Key targets
Writing in July, I highlighted four of management’s financial targets:
- Turn free cash flow (FCF) positive (excluding disposals) at some point during the second half of 2021
- £2bn of asset disposals by early 2022
- Annualised savings of over £1.3bn by the end of 2022
- FCF of at least £750m as early as 2022
I wrote that I was optimistic management would be able to reaffirm these targets in the half-year report. And that, if so, I’d expect the market and the Rolls-Royce share price to respond positively.
Target #1
Rolls-Royce reaffirmed: “We continue to expect to turn FCF positive sometime during the second half of this year.” Good news, although not in the bag yet. There’s still a risk of a miss, due to the timing of certain cash outflows in civil aviation.
Target #2
The company also reiterated its £2bn asset disposals target. The day before the results, it announced the sale of Bergen Engines. Subject to certain closing conditions, completion is scheduled for 31 December. It also confirmed media speculation that it’s entered exclusive discussions on a potential sale of ITP Aero.
With Rolls also expecting to complete the sale of its Civil Nuclear Instrumentation & Control business this year, I see the latest news on the disposal programme as positive for the Rolls-Royce share price. Having said that, ITP Aero is the biggie, but furthest away from being a done deal. At this stage, despite entering exclusive discussions, “there can be no certainty that an agreement will be reached.”
Target #3
Management said it expects to deliver more than £1bn of savings in 2021, putting it “on track” to achieve the targeted annualised savings of over £1.3bn by the end of 2022. Another positive and there now seems to me a relatively low risk of missing this target.
Target #4
Here we get to where the report knocked one of the planks of my investment thesis. On the target of FCF of at least £750m as early as 2022, management said: “Based on current industry forecasts for the pace of recovery in international travel, this is likely to occur beyond the initial expected timeframe of 2022.”
Rolls-Royce share price and value
When I was writing last month, the yield on Rolls-Royce’s targeted £750m FCF was 8.6%. In the past, when the stock has been in favour with the market, the FCF yield has been less than half that. I felt this gave me a good margin of safety against management’s targets proving overambitious.
Today, with the share price higher, the FCF yield is down to 8.1%. And, disappointingly for me, it’s likely that £750m target will take a little longer to reach.
However, with Rolls reporting good progress on its other targets, and management also “positive on the near-term opportunities” in its defence, power systems and other businesses, I think there’s still a decent margin of safety against target-delivery risks.
As such, the stock continues to look buyable for me.
