Rolls-Royce shares drop After Citi Research downgrades to 'neutral'

Investing.com -- Rolls-Royce's (LON:RR ) shares fell over 3% on Monday following a downgrade from analysts at Citi Research, who revised their rating on the stock to "neutral" from "buy.” 

As per Citi, the aerospace and engineering giant's valuation has risen to levels they consider to be near its "fair value," reducing the potential for substantial upside in the stock's performance.

The downgrade came despite Citi increasing Rolls-Royce's target price to 641 pence from 555 pence, reflecting improved long-term cash flow projections and favorable currency effects from the U.S. dollar's recent strengthening against the British pound. 

However, analysts believe the revised target offers limited near-term gains compared to the current share price.

Citi flagged that Rolls-Royce's recovery from the impacts of the COVID-19 pandemic had been robust, with cash flow exceeding reported profits due to the company's unique business model. 

While this supports a higher valuation in terms of cash flow metrics, the shares trade at premium levels when viewed through profit multiples, which could temper investor enthusiasm.

The brokerage also said that while near-term cash flow would likely see a boost from the unwinding of pandemic-related working capital, this trend might not be sustainable. 

Citi's analysts emphasized the importance of considering both cash flow and profitability metrics, suggesting that a perceived disconnect could weigh on the stock's longer-term valuation.

The move by Citi comes as broader market trends and geopolitical uncertainties continue to influence the aerospace sector. 

Rolls-Royce's efforts to improve efficiency and profitability, including a focus on high-margin services, remain a key part of its investment thesis, but Citi believes these are now adequately reflected in the stock's price.

Investors will be watching closely to see how Rolls-Royce navigates upcoming challenges, including maintaining momentum in cash generation and addressing potential headwinds in its civil and defense aerospace divisions. 

For now, Citi's more cautious stance suggests a more measured outlook for the company's stock.

Source: Investing.com