Broker tips: Rolls-Royce, Rio Tinto, SABMiller

11th Feb 2011 13:06

Valuation levels at Rolls-Royce are starting to look more compelling, according to Nomura, which reiterates its positive stance on the engine maker.The group delivered solid results yesterday, with profits 4% better than expected, despite challenging market conditions and the £56m financial charge related to the Trent 900 engine failure."We continue to think that 2011 earnings risk is biased to the upside from what could be a stronger than expected rebound in commercial aerospace aftermarket sales and renewed strength in the offshore part of the marine division," says analyst Jason Adams.Given the company's strong top-line growth outlook and pricing power, the broker believes Rolls should trade at a premium to the wider industrials sector.The Japanese broker keeps its 'buy' rating and target price of 725p.Credit Suisse says that Rio Tinto's recent $5bn share buy-back should settle concerns over its use of cash, keeping the stock on its 'Focus List'.The broker says that the buy-back, announced Thursday, is a good sign that the mining giant is willing to increase cash returns alongside a capital expenditure-intensive growth strategy, and estimates that it will be 2-3% earnings per share-accretive once complete."We continue to believe that Rio offers significant re-rating potential from the majors into a synchronous steel/iron ore demand recovery this year," the broker says."Looking back to 2004-07, despite a strong uplift in cash flows it took a year or two before free cash flows were matched by cash returns as confidence in the cycle improved."With net debt forecast to be around $16bn by the end 2012, it leaves further room for higher dividends and buy-backs in 2011-12. An 'outperform' rating and 6,000p target price are kept.RBS upgrades the world's second-biggest brewer SABMiller from a 'hold' to a 'buy' as the lager maker's increasingly low gearing levels raise the issue of value-enhancing use of capital. The broker's scenario analysis encompasses a range of options that could be value-enhancing for shareholders, such as an improved dividend payout or a share repurchase programme. However, it is noted that both options have complicating factors. "The dividend payout ratio is already high relative to the other European brewers and we believe that SABMiller would be reluctant to engage in an open-market share buyback programme whilst its strategic stakes are still outstanding owing to its effect on the free float," says analyst Jonathan Cook.Another scenario is for SABMiller to continue with its long-term growth strategy of mergers and acquisitions. The broker says that the most obvious options would include Foster's or the buy-out of existing minority partner, Castel and CRE. Either way, "some of these could be immediately value- and earnings- accretive to the company," says Cook.RBS sees scope for a rerating based on potential value-accretive use of capital, and ups the target price from 2,350p to 2,400p.