Rolls-Royce share price receives a rare analyst downgrade

Rolls-Royce (LON: RR) share price drifted downwards on Tuesday after the industrial giant received a rare downgrade. The stock, which peaked at 313p in December, retreated to a low of 292p, the lowest point on January 5th. Despite the retreat, it is one of the best-performing FTSE 100 constituents as it jumped by over 180% from its lowest point in 2023.

Rolls Royce shares chart

The main reason for the retreat is a negative note from Berenberg analysts who warned that the rally was overstretched. In their note, they identified a few issues that could hurt the company in 2024. First, they noted that the company could come under margin pressure in the coming years, hurting its performance.

Second, Berenberg expects that the company, together with Airbus, could come under pressure as customers push back on prices. This is notable since Rolls-Royce makes most of its money in the civil aviation industry and the management is attempting to boost margins of its engine business. For a long time, Rolls-Royce has sold its engines at low margins or even for a loss in exchange of the lucrative long-term servicing contracts.

Finally, the analysts see some engine problems in the company’s XWB-97 in hot and sandy locations. They believe that these challenges, while minor for now, could derail its margins in the short and medium-term.

The downgrade by Berenberg makes it the most pessimistic. In a recent note, analysts at UBS maintained their bullish rating for the stock while Barclays boosted their target. Bank of America raised its target to 350p while Fitch upgraded the company’s credit rating. In all, 12 analysts have a buy rating on the stock while 5 have a hold and 1 has a sell. 

Rolls-Royce Holdings’s management is now working on a plan that it expects will lead to higher sustained profits for years. In its recent strategy call, the management set an operating margin target of 13% to 15% and free cash flow target of between 2.8 billion and 3.1 billion pounds. They also expect to boost the return in capital to between 16% and 18%.