Time To Buy Rolls-Royce Holding PLC And BAE Systems plc?

Rolls-RoyceOur two big aerospace engineers, Rolls-Royce (LSE: RR) (NASDAQOTH: RYCEY.US) and BAE Systems (LSE: BA) (NASDAQOTH: BAESY.US) are seriously looking undervalued these days.

Cuts in defence spending during the recession hurt both companies, but their share prices have behaved differently. Both took a tumble in the dark year of 2009, and BAE’s remained depressed. Since 2012, the BAE price has been recovering a little, but over five years it’s still quite a bit behind the FTSE with a gain of only around 20% — the index has risen by 55% over the same timescale.

Rolls has been strong

Rolls-Royce, on the other hand, quickly headed back upwards and over five years has trebled in price while the FTSE has achieved only that 55% – but the past two years have not been good. With its 2013 results announcement, Rolls told us that “In 2014, we expect a pause in our revenue and profit growth” — and that was the first time in a decade that the firm has not expected to grow its revenues.

The price slumped, and at 1,070p today it’s down 10% over 12 months — and that’s even after a 6% rise this morning!


What caused today’s spike? It’s the news that Rolls-Royce is set to embark on a share buyback programme. The company has completed the sale of its energy gas turbine and compressor business to Siemens, and now has a spare £1bn in cash sitting around. Chief executive John Rishton told us that “As no material acquisitions are planned, and reflecting the strength of our balance sheet, we will return the proceeds of the Energy sale to our shareholders“.

The return of cash is to happen via a share buyback rather than any kind of special dividend, and that suggests that Rolls-Royce considers its shares to be good value right now.

On a pure P/E basis, the shares look pretty averagely-valued — they’re on a forward multiple of 15 for this year, dropping to 14 for 2015 as earnings growth forecasts return. But with a great record of long-term earnings rises, Rolls has traditionally enjoyed a higher P/E than average, for good reasons.

How’s BAE looking?

BAE doesn’t have the same rock-solid earnings record as Rolls, and we have a couple of flat years forecast — but the shares are on a forward P/E of only 10.5. Dividends look set to yield close to 5% this year and next, and should be around twice-covered. And going by BAE’s most recent update, it should be able to ride out the era of lowered defence spending just fine, and looks in good shape for a continuing recovery from recession.

Both companies look like good value to me.

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Alan does not own any shares in BAE Systems or Rolls-Royce.