Is this the next big FTSE growth stock?

This FTSE firm was spun off from the UK Ministry of Defence in 2001, since when its has seen orders surge, and it looks very undervalued to me.

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Unlike some better-known FTSE defence companies, QinetiQ Group’s (LSE: QQ) shares haven’t tripled in value over the past two years. The FTSE 250-listed firm has seen its share price rise by ‘just’ 42% during that time.

My experience as a former investment bank trader taught me a few things though. One is that the big, shiny names in an asset class tend to benefit first from investor funds moving into a new trend.

Another is that often even more money can be made from assets the next rung down. This is on the strict proviso that there is quality there as well, so I’ve had a long look at QintetiQ.

Rising trend of global insecurity

The new trend here, sadly, is dramatically rising global insecurity. The Russia-Ukraine and Israel-Hamas wars rumble on, and there are fears Chinese President Xi Jinping could try to seize Taiwan.

At the Munich Security Conference in February, NATO member countries vowed to increase their defence spending to at least 2% of gross domestic product.

This followed US presidential hopeful Donald Trump’s comments that his administration wouldn’t protect NATO members that didn’t meet that target.

Is the business strong and growing?

QinetiQ was formed in 2001 by the UK’s Ministry of Defence, specialising in testing and evaluation systems, among others.

Its H1 2024 results showed a 19% rise in orders over H1 2023 to a record-high £953m. And the order backlog increased to £3.13bn from £2.97bn in the same period the previous year.

Underlying revenue jumped to £883m in H1 2024 from £673m in H1 2023. And underlying operating profit during the period rose to £100m from £74m in the previous period.

A Q3 trading update on 16 January showed year-to-date orders of around £1.35bn. Its US Avantus operation – bought in November 2022 – has won $872m of new contracts in the year to date.

Analysts’ expectations are now that earnings will rise by 16% a year to end-2026. Earnings per share are projected to increase by 18% a year to that point.

One risk to these projections is that the world suddenly becomes a much less dangerous place, much as we’d all like that to happen. Another is that a major product proves substandard and requires costly redesign.

Undervalued against its peers?

On the key price-to-earnings (P/E) stock value measurement, QinetiQ trades at 19.2 against a peer group average of 35.1.

So, it looks very undervalued on this basis, despite its recent share price rise. But how undervalued?

discounted cash flow model showed it to be around 49% undervalued at its current price of £3.60. Therefore, a fair price would be about £7.06 a share.

This doesn’t automatically mean that the stock will ever reach that level. But again, it confirms to me how undervalued it still looks.

Additionally positive for the price is the planned £100m share buyback planned by the firm this year. These tend to support share price rises.

So will I buy it?

I already have a holding in the defence sector, so buying another would unbalance my portfolio.

But if I didn’t have it, I would buy QinetiQ as I think it could become a major growth star in the coming years.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Simon Watkins has no position in any of the shares mentioned. The Motley Fool UK has recommended QinetiQ Group Plc. 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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