Morgan Stanley expects Rolls-Royce to increase its share of the market for installing engines in widebody aircraft to 50% by early 2020.
This will be supported by the company’s exclusive deal to supply the engines that power the Airbus A330neo and A350 widebody jetliners, the investment bank said.
“Market share gains in the widebody installed base will drive cash flow growth ahead of peers for at least the next five years, in our view,” Morgan Stanely said.
“Cash quality should markedly improve, and help close the discount to peers.”
Rolls-Royce trades on a 20% discount to the average of closest peers Safran and MTU Friedrichshafen on 2020 FCF multiples, the broker said, adding that it expects an FCF CAGR over 2020-23 of 16%, compared to 10-11% for rivals.
Rolls-Royce free cash flow to top £1bn in 2020, Morgan Stanley expects
Morgan Stanley estimates a 10% compound annual growth rate (CAGR) in Rolls-Royce flying hours over 2018-22 and 5-6% CAGR in its installed base of engines.
The broker said this underpins its forecast for more than £1bn in free cash flow (FCF) in 2020 and £1.9bn in the mid-term around 2024, in line with the company’s targets.
“Our fundamental argument is that Rolls-Royce is replacing lower quality cash flow with higher quality cash flow over the next several years,” Morgan Stanley said.
“A growing share of the installed base drives higher aftermarket flying-hours payments.
"We view this as a stable and growing component of cash flow, which we expect to be more highly valued than recent working capital improvements.”
Morgan Stanley added that improved visibility on the cost of Rolls-Royce’s Trent 1000 engines, demonstrably increasing rigour on investments and progress on restructuring have increased its confidence in its mid-term FCF estimates.
Risks facing Rolls-Royce
Addressing some of the risks to Rolls-Royce, Morgan Stanley said: “We have previously highlighted that order cover is shorter and market traffic growth lower in the widebody segment, though Rolls-Royce's share gains offset some of these concerns.
It added: “Accelerated retirements on RB211 mature engines could be a headwind to high margin aftermarket activity.
“Whilst the picture on Trent 1000 challenges is much improved, further engineering issues on new engine programmes cannot be ruled out.”
Last month, Roll-Royce reported a 7% rise in 2018 revenue to £15.73bn while operating profits doubled to £616mln thanks to a “significant improvement” in the civil aerospace business.
In mid-morning trading, shares in Rolls-Royce gained 1.2% to 909p.