Of all the growth prospects in the FTSE 250, my eye has been drawn to QinetiQ (LSE: QQ).
What is it?
The UK’s Ministry of Defence (MoD) created the firm when it split its Defence Evaluation and Research Agency in 2001. QinetiQ was the bigger part and the Defence Science & Technology Laboratory the smaller portion.
In 2003, the company signed a long-term partnering agreement (LTPA) with the MoD for its Test and Evaluation technology. This was worth up to £5.6bn over 25 years.
2019 saw an additional £1.3bn LTPA agreed for the firm to modernise 16 of the MoD’s critical defence facilities.
This year, the MoD named QinetiQ as key supplier on its new £1.2bn Digital and IT Professional Services (DIPS) framework.
How does the defence sector look?
It appears that the world is becoming an ever more dangerous place, much as we do not want this.
However, for companies like QinetiQ that provide offensive and defensive military technology, it presents enormous opportunities.
The UK’s recent commitment to spend 2.5%+ of its gross domestic product (GDP) each year on defence by 2030 have bolstered these.
It has already led to an acceleration in the rollout of the UK’s ‘DragonFire’ laser programme on Royal Navy ships. QinetiQ is a key partner in this.
May saw the completion of trials involving advanced quantum-based navigation systems that cannot be jammed or spoofed by enemies. QinetiQ collaborated on this with BAE Systems and Infleqtion.
How is it doing?
One risk in the firm is a failure in any of its key products, which can prove costly. Another is that the world suddenly becomes less dangerous, much as we would like to see that.
However, analysts estimate that its earnings will grow by 11.1% a year to the end of 2027. Return on equity is forecast to be 17.6% by that time.
Moreover, QinetiQ’s 2024 results released on 12 June showed revenue jump 21% year on year — to £1.912bn from £1.58bn. This was ahead of expectations, as was underlying operating profit rising 20%, to £215.2m from £178.9m.
Its order book increased to £1.74bn from £1.72bn, and underlying earnings per share rose 11% — to 29.4p from 26.5p.
This all adds up to me to it looking like one of the best growth prospects in the FTSE 250.
Share price potential
Better still from my perspective is that there appears to be a lot of value left in the share price.
QinetiQ trades at a price-to-earnings ratio (P/E) of just 18 – less than half the 36.8 average of its peers.
To find out exactly how much of a bargain it is, I used a discounted cash flow analysis. This reveals the firm to be 46% undervalued at its current price of £4.45.
Consequently, a fair value for the shares would be £8.24, although there is no guarantee they will reach that.
If I did not already have shares in BAE Systems, I would buy QinetiQ shares today.
In my view, it has excellent growth prospects, which should power share price gains.
They should also drive the company’s currently modest dividend yield (1.9%) much higher as well, I think.
