Morgan Stanley reiterates 'overweight' stance on Rolls-Royce

Analysts at Morgan Stanley reiterated their 'overweight' recommendation for shares of British engineering company Rolls-Royce on Tuesday, with improved cash flow quality expected to result in an increased focus on its improving fundamentals over the next twelve to eighteen months.

The investment bank believed improving cash flow quality could drive a reappraisal of the group's fundamentals and, with Rolls-Royce having underperformed the sector on a two-year view, during which time the debate had been dominated by discussion on the quality and timing of cash flow.

The firm's growing installed base, rigorous cost discipline and operating leverage would drive FCF growth "significantly ahead of peers" post-2020, the analysts said in a research report sent to clients.

"If Rolls-Royce achieves its mid-term targets, the stock could double on a five-year view," they added.

Looking out to the medium-term, the broker highlighted five positive drivers for Rolls-Royce's share price, including the widebody replacement cycle of older 747s and 767s, Installed base gains, a higher share of maintenance revenues, pricing tailwinds and its improved operating leverage given its much smaller aftermarket base than peers.

"We have been surprised how little attention is focused on underlying drivers, and believe this can change," Morgan Stanley said.

While the investment bank noted that cash was still a battleground for the stock, the analysts said it was a "nice problem to have". Crucially, Morgan Stanley expected that the improvement in the quality of FCF over the next year would make this debate "largely redundant".

Morgan Stanley also kept its 1,100p target price unchanged.