After more than doubling in 2023, Rolls-Royce (LSE: RR) shares are now at 211p. Yet investment bank UBS reckons the FTSE 100 stock could top 600p, in a best case scenario. That would represent a near tripling in the share price!
Here are five things that could help it get there.
Increasing cash flow
In the first half of 2023, Rolls-Royce generated £356m in free cash flow (FCF) from continuing operations. This compares to an outflow of £68m in the same period last year. For the full year, it now expects between £900m and £1bn of FCF, which is significantly ahead of previous expectations.
Management noted that this return to positive cash generation was due to “greater productivity, efficiency, and improved commercial outcomes“.
However, UBS believes management’s 2023 guidance is conservative, and is forecasting towards the top end of the guided range. And it thinks that Rolls-Royce could achieve £2bn in FCF as soon as 2024, with the potential for £2.8bn in underlying FCF in 2026.
If this proves accurate, which isn’t guaranteed, it could be a major catalyst for the share price.
Reducing the debt pile
Importantly, this cash could be put towards reducing the firm’s net debt. This is the debt that the business took on to survive the pandemic. It stood at £2.8bn in June, down from £3.3bn at the end of last year.
CEO Tufan Erginbilgic has made it a priority to reduce it further and reclaim the group’s investment-grade credit rating. And S&P, the credit rating agency, has said that the engineer’s debt might indeed return to investment grade over the next 12 to 18 months.
If the balance sheet officially becomes less of a risk, that would be another important development.
Full recovery in engine flying hours
Nearly half of the firm’s revenue in the first half came from its civil aerospace division. This unit makes engines for Airbus A350 and Boeing 787 planes, meaning its fortunes are tied to commercial flying hours.
So it’s encouraging that large engine flying hours have now reached 83% of pre-pandemic levels. Management thinks this figure could reach 80% to 90% this year.
A full recovery in this area of the business would be highly symbolic, though the ongoing problems in China’s economy could delay that from happening.
Continued defence progress
Its Defence division has been busy in recent months. Notably, it signed a deal in March to provide the reactors for Australia’s nuclear-powered submarines. This appears to be a significant long-term contract win.
In H1, this unit improved its operating profit and margins. Meanwhile, the order intake surged 87% to £2.7bn, which bodes well for future growth.
Ongoing progress here looks likely as military budgets rise in response to geopolitical tensions.
Return of the dividend
Finally, I think a reinstatement of the dividend could help send the shares to 600p. Bank of America sees the potential for a return of dividend payments as early as 2024. However, that would depend on the company reducing its net debt and improving its credit rating.
I think it’ll be a tall order for the stock to reach 600p anytime soon. But given these potential catalysts, I’m happy to hold my Rolls-Royce shares for the long haul.
