Aerospace and defence companies Rolls-Royce (LSE: RR) and BAE Systems (LSE: BA) are both companies that I would consider worthy dividend picks. But which is the better high-yield play? Let’s take each company in turn.
Although I have written about how low oil prices will improve the prospects of the airlines, what about aeroengine manufacturers such as Rolls-Royce?
Well, if the low oil price is sustained, then I expect that air fares will fall and more people will be flying. This in turn will lead to increasing air traffic volumes, and this means more planes will be built. So aeroengine companies like Rolls-Royce should benefit. The firm’s marine business is also likely to gain, as global trade and shipping increase.
But these trends are complicated by the fact that Rolls-Royce’s defence arm will be affected by falling defence spending. I expect the company will realign itself to place more emphasis on civilian rather than military aerospace.
Rolls-Royce has until recently enjoyed a bull market, with the share price quadrupling from the depths of the credit crunch in 2009 to its peak around late-2013. But over the past year, profits and the share price have fallen. The earnings per share progression tells the story:
Despite Rolls-Royce’s recent troubles, the shares are reasonably priced, with a 2015 P/E ratio of 14, and dividend yield of 2.6%. Overall, I still believe in the firm’s growth story over the next decade, even though currently it seems to be meeting some turbulence.
BAE Systems is the UK’s leading defence company. Although it has had a difficult few years, the share price has recovered strongly as the business has adapted to a world where defence spending is trending downwards, with an increasing proportion of spend from emerging markets.
The fact that, unlike Rolls-Royce, all of BAE Systems’ business is defence-related, makes me less positive about this firm’s growth prospects. Yet its focus on technology means that it is very much looking to the future of defence.
Its EPS progression shows that earnings are now increasing:
And the shares are priced at a similar level to Rolls-Royce, with a 2014 P/E ratio of 13.7, falling to 13.0. The dividend yield is 3.9% rising to 4.0%. This is much more of a dividend play than a growth play.
Foolish bottom line
Overall, I would say both companies are worthy investments. But as the global airline industry recovers, I feel that Rolls-Royce, although it has the lower dividend yield, has the better growth prospects, and thus would be my pick.
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Prabhat Sakya has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.