The BAE Systems (LSE: BA) share price has had a strong run, rising 46% in the last year. It’s been a brilliant 12 months for defence stocks generally, with Rolls-Royce Holdings (LSE: RR) and Babcock International Group (LSE: BAB) both up more than 100%.
I hold BAE Systems and Rolls-Royce and have no intention of selling either. I’m wondering whether to complete the hat-trick with Babcock, but may have enough exposure to this sector for now. Or have they got further to go?
Strong demand, strong results
BAE Systems continues to show why it’s a FTSE 100 mainstay. February’s full-year results showed sales up 14% to £28.3bn while underlying operating profit hit £3.02bn. The order backlog rose to a record £77.8bn, giving long-term visibility few can match.
The group also lifted its dividend by 10% and expects 2025 underlying profits to grow between 8% and 10%. The shares now trade at a price-to-earnings (P/E) ratio of around 27, so a lot of future growth already seems priced in. But as long as global instability persists, that premium may be here to stay.
All stocks have risks. BAE relies heavily on a handful of large government customers, particularly the US and UK. A change in political leadership, budget priorities or foreign policy could affect future orders or contract renewals. Today though, it’s on fire.
Powering ahead
Rolls-Royce has gone nuclear — literally and figuratively. The share price has surged 860% over five years and now trades on a sky-high P/E of 46.
On 1 May, the group issued a bullish trading update, forecasting £2.7bn-£2.9bn in underlying operating profit. All divisions are said to be performing well.
Rolls has been selected to build small modular nuclear reactors in the UK. This could be a landmark moment for the business. Yet the tech still isn’t fully proven. Also, while flying hours in Civil Aerospace are 10% above 2019 levels, economic or geopolitical turbulence could always knock that. Plus there are lingering concerns about its Trent engines.
FTSE 100 grower
Babcock’s a name I’ve kept half an eye on but never quite bought into. Am I too late? The Babcock share price soared on 25 June after the group posted a jump in annual operating profit from £241.6m to £364m and launched its first-ever share buyback.
Management expects to hit its 8% operating margin target a year early and has lifted its medium-term margin forecast to at least 9%. Its order book has nudged up to £10.4bn.
The P/E of 22 doesn’t seem outrageous, comparatively. However, Babcock’s still in the early stages of its turnaround plan. Any slip-up in project delivery or cost control could hit investor confidence, especially after such a rapid share price climb. Delays, cost overruns or renegotiations on its long-term contracts could hit revenue.
Room to run?
Rolls-Royce is more than a defence stock now. It’s evolving, with civil aerospace still growing and nuclear opportunities ahead. The other two are more traditional defence plays, but in today’s world, it’s hard to bet against any of them.
After such a blistering run, all three are likely to slow. I won’t be adding to what I have, but for those who have nothing in this space, I’d consider building a position in any of them.
