Can Meggitt's growth continue and are the shares cheap?
Capital appreciation is surely the goal of many investors. One method of achieving that is to buy companies with steady earnings growth. If bought when the shares are cheap, two drivers could move the share price up:
- growth in earnings, and
- an upwards P/E re-rating.
Highly successful fund manager Peter Lynch classified steady growers as Stalwarts, which he typically traded for 20% to 50% share-price gains. But whether buying for gains like that or holding for the longer term, we need to know if reliable earnings growth can continue, and whether the shares are cheap.
Seeking durable growth
Not all companies achieve stable growth as you can see by the aggregate performance of those in London's premier FTSE 100 index (UKX), where the compound annual earnings-growth rate has been just 0.7% over the last five years:
| Year to June | 2007 | 2008 | 2009 | 2010 | 2011 | 2012 |
|---|
| FTSE 100 index | 6,608 | 5,626 | 4,249 | 4,917 | 5,946 | 5,571 |
| Aggregate earnings per share | 537 | 503 | 427 | 397 | 527 | 557 |
Consistent, cash flow-backed growth in profits is a promising characteristic in today's markets so, for this series, I'm examining firms with annual earnings growth between 4% and 20%.
One contender is Meggitt (LSE: MGGT), which provides systems and electronics for the aerospace and defence industries. This table summarises the company's recent financial record:
| Trading year | 2007 | 2008 | 2009 | 2010 | 2011 |
|---|
| Revenue (£m) | 878 | 1,163 | 1,151 | 1,162 | 1,455 |
| Earnings per share | 22.1p | 26.5p | 25.3p | 27.8p | 31.9p |
So, earnings have grown at an equivalent 9.6% compound annual growth rate putting the company in the Stalwart category.
Meggitt describes itself as a global engineering group specialising in extreme environment components and smart sub-systems for aerospace, defence and energy markets. It employs around 10,000 people worldwide to produce things like control, sensing, and aircraft breaking systems, and polymers and components.
Civil aerospace accounts for 46% of revenues, military 40% and other markets 14%. Its most important territory of operations is the US, which delivers around 56% of revenues, followed by its 'rest of Europe' category with 22%, the rest of the world at 13% and 9% from the UK.
As well as earnings from new installations, the company enjoys a cash-generative maintenance and spares business too. With more than 57,000 aircraft installations worldwide, there is what the company calls a "stable aftermarket stream stretching out for many years."
If Meggitt can keep winning new business as well, the prospects for rising earnings look promising.
Meggitt's earnings growth and value score
I analyse five indicators to determine whether earnings growth can continue and if the shares offer good value:
1. Growth: revenue, earnings and cash flow all growing steadily. 5/5
2. Level of debt: net debt is around 3.5 times annual underlying profits. 2/5
3. Outlook and current trading: good recent trading and a cautiously positive outlook. 4/5
4. Enterprise value to free cash flow: above historic growth rates at about 14. 2/5
5. Price to earnings: at around 12, slightly above historic growth rates. 2/5
Overall, I score Meggitt 15 out of 25, which encourages me to believe this stalwart can continue earnings growth that out-paces that of the wider FTSE 100. The company seems to have a full price when compared to the FTSE's price to earnings ratio of around 11 and the firm's growth predictions.
Foolish Summary
Although there is a big chunk of debt Meggitt manages interest payments easily from its strong cash flows. It's encouraging to see good recent trading and a positive outlook.
Right now, forecast earning growth is 9% for 2013, and the forward P/E ratio is 10.6 with the shares at 403p. Considering that and the other factors analysed in this article, I think that the firm can stay on watch, for now.
Meggitt is one of several steady-earnings-growing stalwarts on the London stock exchange, each with the potential to deliver significant capital appreciation when purchased at sensible prices.
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> Kevin does not own any shares mentioned in this article.
