Can Rolls-Royce Holding Plc Oust BAE Systems plc And QinetiQ Group plc From Your Portfolio?


With the Farnborough airshow in full swing, it seems only appropriate to concentrate on three defence-focused companies that could have bright futures.

Indeed, just this week Rolls Royce (LSE: RR) (NASDAQOTH: RYCEY) announced that Airbus had decided to use the company’s newly launched Trent 7000 engine as the exclusive engine for its new Airbus A330 ‘Neo’. This is positive news for Rolls Royce and shows that the company continues to match peers when it comes to new development and, crucially, new orders.

Looking ahead, though, can Rolls Royce really offer investors enough potential to oust BAE (LSE: BA) (NASDAQOTH: BAESY) and QinetiQ (LSE: QQ) from their portfolios?

Mixed Valuations

When it comes to which of the three companies offers the best value, there is one clear winner: BAE. That’s because it trades on a price to earnings (P/E) ratio of just 10.7, which is considerably lower than the P/Es of Rolls Royce (16) and QinetiQ (14.3). A key reason, of course, for this could be weaker market sentiment for BAE, after the company delivered a profit warning earlier this year.

Despite this, earnings are set to fall by only 7% this year, before increasing by 3% next year. Indeed, these growth numbers compare relatively well to those of Rolls Royce and QinetiQ, where earnings per share (EPS) are forecast to be flat and fall by 7% respectively this year. Next year, though, is a different story and on this front Rolls Royce dominates, with it being expected to post EPS gains of 11%, while QinetiQ is not too far behind, with forecast increases of 7%.

Mixed Yields

As with valuations, yields among the three stocks are varied. Again, BAE leads the pack, with shares in the company currently yielding an impressive 4.9%, versus 2.2% for Rolls Royce and 2.4% for QinetiQ. Of course, all three companies have the potential to significantly raise dividends per share, with payout ratios being 50% or below at all three companies. However, they seem to prefer to reinvest profit in the business and, certainly in Rolls Royce’s case, this seems to be a sensible move, since it appears to offer the best growth potential of the three. So, while its yield is below that of its two peers, the reinvestment of capital should deliver relatively strong growth going forward.

Looking Ahead

While all three companies appear to be relatively sound, BAE should appeal most to income-seeking investors who are patient enough to wait for a potential upward revision to its rating. It may, of course, take results that are in-line with expectations to restore confidence after the profit warning. Meanwhile, Rolls Royce offers the best growth potential, while QinetiQ seems to offer a mixture of income and above-average growth prospects, too. Therefore, all three companies could prove to be potential winners for longer term investors.

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Peter Stephens owns shares in BAE.  The Motley Fool has no position in any of the shares mentioned.