BAE Systems
BAE Systems (LSE: BA) has been hit hard by defence spending cuts in recent years, but there are signs that things are beginning to turnaround. Orders for new equipment and servicing contracts have begun to pick up recently, particularly from the US, and the company has been growing its presence in the faster growing electronic systems and cyber-security markets. These sectors benefit from growing demand not only from the defence sector but also with commercial customers.
The defence company’s strong order backlog of £37.3 billion, worth more than two years of sales, should give the company some certainty over future revenues, even in the absence of any new major equipment sales. This should buy the company time to find new sources of revenues.
Analysts expect underlying EPS will rise 1% to 38.2p this year, with growth accelerating to 5% in 2016. This gives its shares a forward P/E of 11.4, which should fall to just 10.8 on its 2016 forecast earnings.
Rolls-Royce
Shares in Rolls-Royce (LSE: RR) have been battered by a series of profit warnings that began in early 2014. Its commercial aviation engine division, which had been the only major engine of growth, joined other segments of the company to report declining revenues and earnings.
Operating costs had been rising as the company prepared to launch its new Trent 7000 engine, and customers had been holding off orders for older engines in anticipation of the launch of newer, more powerful and more efficient models. As a result, weaker results from commercial aviation should only be temporary.
As demand for wide-bodied commercial engines remains buoyant, longer term fundamentals remain in the company’s favour. This means growth from commercial engines should more than offset the weakness in the defence, marine and power systems businesses in the longer term. But, in the short term, more pain should be expected. Its shares are valued with a forward P/E of 12.8.
GKN
GKN (LSE: GKN) has also recently suffered a downturn in earnings over the past year. Falling commodity prices has hurt demand for its Land Systems business, which manufactures components for larger equipment used in mining, construction and agriculture. Although the company continues to benefit from strong civil aerospace demand and growth from automotive sector, overall group sales declined by 1% in the first half.
The company is looking to offset weakness from its Land Systems business with further investments in the faster growing electric powertrain and aerospace markets. With recent acquisitions in the aerospace market, GKN should benefit from consolidation in the sector through higher margins. Aircraft manufacturers have long companied about the complexity and fragmented nature of the market for aircraft supplies and welcome the formation of larger of players in the market.
Analysts expect underlying EPS will fall 11% this year, to 25.9p, which gives its shares a forward P/E of 10.4. But, for 2016, analysts expect underlying EPS would rebound by 7% to 27.9p, which means its forward P/E should fall to just 9.9 by 2016.
Johnson Matthey
The falling platinum price had much to do with Johnson Matthey‘s (LSE: JMAT) recent profit warning, but rising competition and an overexposure to the oil and gas markets are also to blame. Although the trend of stricter emission controls globally and recovering vehicle sales in North America should offset some of the decline in the precious metals business and weaker oil and gas capital spending, the company may need to more to find new sources of revenues.
In addition to making acquisitions to grow its business, Johnson Matthey has plans to return capital to investors from the recent sale of its Refining and Research Chemicals businesses. In addition, it is expected to pay a dividend of 73.8p per share this year, which gives its shares a prospective dividend yield of 2.9%. Its shares are not as cheap as the other three stocks mentioned here, currently trading on a forward P/E of 14.1, which analysts expect should fall to 13.2 by 2016.
