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Meggitt plc Crashes 20% On Profit Warning: Is It Now A Buy?

Shares in aerospace and defence supplier Meggitt (LSE: MGGT) have fallen by over 20% today after the company issued a profit warning. It now expects underlying operating profit for the full year to be meaningfully below the current market consensus of £369m and, as a result, is implementing cost saving initiatives which include the loss of approximately 300 jobs.

The reason for the profit warning is a marked deterioration in the markets in which the company operates. While trading in the company’s civil original equipment division improved by 2% in the third quarter of the year, elsewhere there was major disappointment. For example, its civil after-market division experienced flat sales versus the comparable period from last year, while its military sales fell by 2% and its energy division saw sales fall by 16%. This resulted in an organic decline in sales of 1% in the quarter.

Looking ahead, Meggitt expects the challenges faced in the third quarter to continue into the final quarter of the year. It anticipates that the lower than forecast spares volumes for older civil and military aircraft, as well as reduced volumes and a number of programme deferrals announced by customers, will not improve in the short run. And, while Meggitt’s cash flow remains strong, financial gearing will be higher than the previously guided level of 2.1x net debt:EBITDA.

Clearly, today’s update is hugely disappointing and it has pushed the company’s share price to a four-year low. In the short term, further pressure may be exerted on Meggitt’s valuation, since its financial performance is unlikely to improve significantly in the coming months. Therefore, today does not appear to be the perfect moment to buy a slice of the business.

However, once the dust settles and the company’s share price begins to stabilise, Meggitt could prove to be a very appealing long-term buy. Although today’s update shows that the defence and aerospace market remains highly unpredictable and very challenging, there is reason to be optimistic regarding its long term growth prospects.

For example, the US economy is going from strength to strength and, although austerity is set to remain a feature of developed world budgets in the medium term, defence spending is likely to increase in the coming years, while economic growth is likely to boost civil aviation’s demand for Meggitt’s products.

Based on last year’s net profit, Meggitt now trades on a price to earnings (P/E) ratio of just 10.9, which indicates that its shares offer good value for money. Certainly, there is scope for this rating to fall – especially if profit forecasts are downgraded even further. However, in the long run there is scope for an upward rerating and, with Meggitt offering a yield of 4.4%, it has now become a realistic income play.

So, while today’s 20%+ share price fall is a major setback, it presents an opportunity to, in the coming weeks and months, buy a slice of a high-quality defence and aerospace business which, in the long run, is likely to prove to be a sound income and value play.

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Peter Stephens 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.