Rolls-Royce turnaround gets a lift with Goldman Sachs backing struggling engineer

Rolls-Royce has been given a lift by Goldman Sachs, with an upgrade from the heavyweight broker sending the company’s stock soaring.

Shares in the FTSE 100 business surged 5.2pc to 705p in early trading after Goldman raised its rating from "neutral" to "buy" and added Rolls to its “conviction list” of preferred stocks.

Rolls-Royce 1-year share price change

The upgrade follows Rolls reporting a record £4.6bn loss last week as it took a massive hit on the value of its $38bn of foreign currency investments intended to protect it from currency swings.  Fines of almost £700m after Rolls admitted corruption practices dragged it further into the red.

Until Goldman's upgrade gave them a lift, Rolls shares had fallen 10pc since it posted the dire results.

A comprehensive note said the upgrade - which lifted the target price on the shares from 743p to 1030p - was driven by a combination of the company generating more cash, rising deliveries of Trent XWB engines for Airbus’s latest airliner, and service revenues from these as more of them go into service. Stablising R&D costs and capital expenditure are also forecast to improve the health of the company’s finances.

Rolls has “the potential to substantially increase” free cash flow - the measure of how much money the business has after essential spending - said analyst Chris Hallam. “The building blocks of this performance can already be seen,” he added.

Warren East, chief executive, has told investors to look at the company’s cash flow as a measure of its success because he says its complex accounting procedures have made it difficult to understand how the company is functioning.

Six profit warnings were issued by the company over the past two-and-a-half years as it stumbled from crisis to crisis, causing its share price to halve - a plunge that cost former boss John Rishton his job.

Mr East was installed in the summer of 2015 with a remit to get Rolls back on track. With new accounting rules coming in that mean Rolls will no longer be able to book future revenues on maintenance contracts on engines sold before it actually receives the money, the chief executive has had to explain that Rolls’ profits are likely to be much lower under the new system. This has led to him focusing on cash flow instead of more traditional measures to value the business.

The Goldman note backed this approach, saying Rolls’ “complicated accounting set-up and reporting changes that impede earnings have refocused investor attention on cash flow”.

Rolls has long lagged behind rivals such as GE and Pratt & Whitney on its margin, often in the mid-to high-single digits, while competitors were in the teens.

Goldman believes that a turnaround under Mr East could deliver margins that compare to the sector average within a year and rise above this level soon after.