Rolls-Royce (LSE:RR) shares have been on quite a bumpy ride these last couple of years. In fact, over the past 12 months, the stock price has continued its downward trajectory by around 27%. But since the publication of its latest results, analysts and brokers have started to change their tune. In fact, some are even predicting the stock will reach as high as 147p by the end of 2023!
What’s behind these new bullish opinions? And should I be considering this business for my portfolio?
Can Rolls-Royce shares make a comeback?
Management released interim results in early August, and the Rolls-Royce share price actually fell on the report. That’s because it was quite a mixed bag of news. Yet there were some underlying encouraging signs that the worst may finally be over.
After the revenue stream was heavily disrupted in 2020 by the pandemic, the business has struggled to stay afloat. It even needed to cut over 9,000 jobs to bring down expenses. As unpleasant as all the tough decisions have been, management’s actions have seemingly started to pay off.
The return of the travel industry has reignited demand for the group’s aerospace services. And pairing that with new defence contracts has restored growth to the top line. Meanwhile, operating margins are also trending up, hitting 4% versus 0.7% a year ago. Combined, this has drastically improved free cash flow. While Rolls remains in the red by £68m, it’s an enormous improvement from the £1.17bn deficit in 2021.
At the same time, Spanish regulators have approved the firm’s €1.7bn (£1.44bn) sale of its ITP Aero business. And with the proceeds being dedicated to eliminating debt, the balance sheet is on track to get a lot stronger.
It seems the cracks in the firm’s financial health are finally being filled. So, I’m not surprised to see analysts become more optimistic about the future of Rolls-Royce shares. But not everyone is convinced.
Not out of the woods yet
I can’t deny that Rolls-Royce is in a far better financial position than a year ago. However, there are still a lot of glaring problems. And it would seem other analyst forecasts agree since some are predicting the stock could actually fall even lower to around 60p.
Seeing such a wide spread in share price predictions is a hallmark of uncertainty. While there are undoubtedly several points of concern, my primary one continues to surround debt.
Even with the proceeds of the ITP Aero sale, the total debt balance will only decline by around 20%. In other words, most of its loans will still be on the books. And with interest rates on the rise, returning earnings to their former glory could take much longer than expected.
If cash flows can continue to climb upward, management should be in a solid position to bring down debt even further. In this scenario, I think it’s plausible for Rolls-Royce shares to hit current forecasts of 147p. But all it takes is another external hiccup to derail the entire recovery process. And if the worst comes to pass, then a 60p price target seems more realistic.
All things considered, this level of uncertainty isn’t something I’m keen on adding to my portfolio today.
