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After the £4bn Cobham sale, which UK defence shares do I think will make the most money in 2020?

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With the controversial £4bn sale of historic British manufacturer Cobham, it’s clear that UK defence shares will never go out of fashion. And in his September 2019 spending review, Chancellor Sajid Javid further committed to funding the Ministry of Defence (MoD) to the tune of £2.2bn over the next two years, an increase of 2.6%.

FTSE-listed firms in this sector continue to flourish, in prime position to win long-term, stable, and lucrative, contracts from the MoD and armed forces around the world. 

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BAE

BAE (LSE:BA.) engineers build the aft fuselage for the next-gen F-35 fighter jet, and alongside working on the UK’s Dreadnought nuclear submarines, also repair US Navy ships. BAE won a $171m maintenance contract for the latter in September 2019. Its electronic systems division won a $2.7bn contract the same month to build laser-guided APKWS rockets with sales planned to Lebanon, the Netherlands, Australia and Tunisia.

BAE shares come with a healthy 3.8% dividend and are priced relatively cheaply for a company this size, with a trailing P/E ratio of just 13. This is one for long-term income investors, with dividends per share rising steadily since 2014, always with cover of 1.8 times earnings or more.

A November 2019 trading update showed earnings per share growing in the mid-single digit percent range, with BAE targeting £3bn of free cash flow between now and 2021. Despite the low-interest-rate environment putting pressure on pensions, I think an investment in BAE is a solid long-term play.

Meggitt

The return of Meggitt (LSE:MGGT) to the FTSE 100 in 2019 came after a four-year hiatus. Those interim years were particularly tough for the components manufacturer and while revenues were rising, profits were going nowhere fast.

Meggitt has benefitted from the astronomical increase in US military spending under President Trump. CEO Tony Wood’s decision to ramp up the Bournemouth-based firm’s American operations has been reflected in the share price.

November 2019 brought the good news of a six-year $130m contract win with the US Defence Logistics Agency to supply fuel tanks to the F/A-18 Super Hornet, the V-22 Osprey and the Super Stallion helicopter. Margins have been hit by Boeing’s catastrophic handling of the 737Max, for which Meggitt makes the engine fire detector system, but the manufacturer still upgraded 2019’s revenue guidance given a particularly strong performance across the year.

TP Group

£51m market cap firm TP Group (LSE:TPG) is much smaller than any of the other defence specialists on this list. Changing its name from Corac in 2015 reflected a switch from research to engineering, and the company now focuses on its space, intelligence and maritime divisions.

In September 2019, it won a £1m MoD contract to upgrade Royal Navy submarines with 750 oxygen generators, following on from a February contract win to furnish the fleet with life-saving lithium hydroxide curtains.

TP Group’s balance sheet is looking the healthiest it has in years. Cash at bank hit £22m in 2019, with earnings per share ticking over into the black for the first time in five years as revenues rose accordingly. Adjusted earnings were up 85% between 2017 and 2018, with order books hitting £48.3m. If this momentum continues, I’d expect the share price to rocket forward in the next three to five years.

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Tom Rodgers owns shares in TP Group. The Motley Fool UK has recommended Meggitt. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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