Inflation is on the rise as we head for Brexit and out of the EU single market, and the falling pound is already pushing up prices of imports. In this environment, from an investment viewpoint I’d be steering clear of anything that depends on discretionary retail spending. But with isolation increasing in these Trump-darkened times, I can see a good time ahead for investing in the defence business.
On the up
Look at QinetiQ (LSE: QQ), whose shares are up 15% over the past 12 months, to 272p. It delivered a third-quarter update on 15 February, which spoke of “encouraging progress in the implementation of its strategy to drive future growth“.
Key strategic progress includes a £1bn amendment to the firm’s long-term partnering agreement (LTPA) with the Ministry of Defence, and QinetiQ’s acquisition of Meggit’s Target System division, both in December. Financially, trading is going as expected, with the LTPA amendment adding around £10m to capital expenditure this year. A £50m share buyback programme is nearing completion.
The gain in the share price has lifted QinetiQ’s forward P/E multiples to around 17 for the next couple of years, which is a bit ahead of the FTSE average. That makes me a little cautious, but it’s probably a fair valuation for a safe investment in these troubled times.
Rolls-Royce (LSE: RR) reported a pre-tax loss of £4.6bn this week. That included writedowns for various reasons, but it’s still the company’s biggest ever loss and is up there with some of the most eye-watering that UK companies have ever produced.
At 695p, the shares are down 6% since the results emerged, but I reckon we should be focusing on the company’s transformation plan. After a couple of very tough years, which brought a string of profit warnings to shock the industry, analysts are now predicting a return to earnings growth.
There’s a 16% EPS rise on the cards for 2017, followed by a further 4% the year after. And the dividend, which was slashed in 2015 and cut further for 2016, should start climbing back again.
We are looking at a predicted P/E of 19 and a modest 2% dividend yield for 2018, but if we genuinely are at a pivot point in Rolls-Royce’s recovery, I think that could turn out to be a good valuation to buy at. And with Warren East, the former head of ARM Holdings, at the helm, I’m once again cautiously optimistic.
My final pick is my favourite in the sector, BAE Systems (LSE: BA). While rivals have been in the headlines (largely for the wrong reasons), BAE has been bringing in steady earnings and paying out solid dividends. Due to the nature of payments for its long-term contracts, earnings can be a little erratic in the short term, and forecasts put EPS at 45.6p by 2018. That’s exactly the same as in 2011, but considering the trading difficulties faced by the sector in recent years years, I think that’s a decent track record.
Dividends have been creeping up, although the share price performance over the fast five years (a 90% rise to 602p) has dropped prospective yields to around the 3.6% level.
BAE’s 2016 results should be with us on 23 February, as the firm expects underlying earnings per share to come in around 5%-10% above last year’s figure. On a forward P/E of 14, BAE looks like top value to me.