After a mixed few years both BAE Systems and Rolls-Royce Holding have picked up speed in recent months, helped by the falling pound. Is now the time to hop on board?
All Systems go!
Defence manufacturer BAE Systems (LSE: BA) has been going great guns lately, its share price up 17% over the past year, and 107% over five years. It has also been handed a significant Brexit booster due to exchange rates, which has increased the sterling value of its ample dollar earnings.
Today’s trading statement confirms the impression of a company firmly on the offensive, with the group’s positive outlook for 2016 remaining unchanged and expected underlying earnings per share (EPS) likely to be 5% to 10% higher than last year’s 36.6p. The statement also highlighted the £1.2bn Typhoon 10-year support partnership agreement in the UK, signed in July, and a “positive” US defence market outlook with expected production ramp-ups on a number of long-term programmes.
BAE is also working with the UK and the Saudi Arabian governments on the next five-year Saudi British Defence Co-operation Programme, which is progressing despite growing international concern over Saudi’s aggression towards Houthi rebels in the Yemen.
Sense of security
The future isn’t all rosy. Standard & Poor’s recently downgraded its rating on the company’s long-term debt from BBB+ to BBB, noting the substantial shortfall in its pensions. Falling gilt yields will only up the pensions pressure, although S&P did suggest that metrics would improve over the next two years, supported by steady operating results and improved cash flow generation.
BAE was hit by post-financial crisis austerity but government defence spending is on the march again, in response to a politically unstable world. The stock currently yields 3.8%, covered 1.69 times. Dividend progression is expected to be steady, if hardly spectacular. Strong past performance would suggest that today’s price of 13.87 times earnings is far from toppy, especially given continuing Middle East uncertainty and increasingly aggressive posturing from Russia and China.
No longer a high Roller
Engineering giant Rolls-Royce (LSE: RR) has given investors a shockingly bumpy ride in recent years. It share price is 32% lower than three years ago, and despite a Brexit bounce (for which it can hardly claim the credit) the stock is only up marginally over the last 12 months. Investors are still reeling from the fact that this illustrious name had issued five profit warnings in just two years, due to falling new orders and a slump in its lucrative after-market as older engines near the end of their working lives. Its credit rating was cut in May, along with many senior managers.
However, there have been no profit warnings since November and Rolls-Royce’s long-term order book is valued at a whopping £79.5bn, up 4% on the year. This includes a $2.7bn new order from Norwegian Airlines for Trent 1000 engines, while its after-market should be boosted by the €720m purchase of its remaining 53% stake in Spanish company ITP.
Chief executive Warren East has a big job turning this crate around and the yield disappoints at 2.15%, after the recent dividend cut. Trading at 12.85 times earnings, his troubles are partly reflected in the price. Rolls-Royce is back on the road but it will be some years before it really starts purring.
