FTSE 250 defence firm QinetiQ (LSE: QQ) is down 16% from its 1 August 12-month traded high of £4.90. However, it is still up 25% from its 16 January one-year traded low of £3.29. And it has jumped 65% from its opening price on 24 February 2022 — the day Russia invaded Ukraine.
In my view, the drop since August is unsupported by recent results. I also think it is based on the false assumption that global security will improve in Donald Trump’s second presidency.
Consequently, now looks like a great opportunity to consider the stock for those investors whose portfolio it suits.
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A false premise
It is true Trump has said he can end the Russia-Ukraine war in a day. It is also true that Israeli actions against Iran’s proxies have reduced Middle East hostilities.
However, it remains the case that the Russia-Ukraine war continues. And Syria looks to be a likely new focal point for further Middle Eastern conflict, in my view.
Additionally, European NATO members are increasing their defence spending to 2%+ of GDP. The shortfall in meeting this target over the past 30 years is estimated at €1.8trn (£1.5trn).
On 2 December, UK defence minister John Healey said the government will outline its plan to increase defence spending to 2.5% of GDP this spring.
A strong core business
QinetiQ looks to me to be in a great position to benefit from such spending increases. It was formed by the UK’s Ministry of Defence (MoD) when it split its Defence Evaluation and Research Agency. Since then, it has become a world leader in the evaluation, integration and securing of military mission-critical platforms and systems.
Its interim H1 2025 results released on 14 November saw revenue up 7.2% year on year – to £946.8m. Operating profit increased 6.5% to £106.6m, and earnings per share rose 6% to 14.2p. Additionally highly positive for me was net cash flow from operations soaring 83% (to £130.9m) while net debt tumbled 30% (to £190.9m). Orders over the period jumped 8.7% to £1.0348bn.
A risk here is that planned defence spending increases are reduced for some reason. That said, analysts forecast that QinetiQ’s earnings will increase 15.19% every year to end-2027. And it is this growth that ultimately powers a company’s share price (and dividend) higher.
How undervalued is the stock?
The firm trades at a price-to-earnings ratio of just 16.3 against an average 28.2 for its competitor group. So it looks very cheap on this basis.
The same is true on the price-to-book ratio, on which it trades at only 2.4 compared to a peer average of 3.1. And it also applies to the price-to-sales ratio, with QinetiQ at 1.1 against a 1.7 average for its competitors.
To ascertain what all this means in share price terms I ran a discounted cash flow analysis. Using other analysts’ figures and my own, this shows the stock is 49% undervalued at its present £4.10 price.
Therefore, its fair value is technically £8.04, although market vagaries might move it lower or higher than that.
Will I buy the stock?
I already own a defence stock (BAE Systems), so having another would unbalance my portfolio.
If I did not have it, I would see QinetiQ as a terrific buy at the current level and would purchase it soon.
