The defence sector has been a tough place to do business in recent years. That’s at least partly because of cutbacks in government spending across the developed world which has meant that sales and profitability of a number of major defence and engineering companies have come under severe pressure.
A notable example of this is BAE Systems (LSE: BA), which released a profit warning in February 2014. Following this its shares fell heavily but have more than recovered in the ensuing 21 months, with BAE’s future being much brighter now that the global economy is offering stronger growth prospects. Of particular note is an improvement in the outlook for the US economy which, as the biggest military spending nation in the world (it accounts for over half of total defence spending across the globe), has a major impact on the defence sector.
Looking ahead, BAE is forecast to return to positive earnings growth next year when its bottom line is forecast to rise by 5%. This is roughly in-line with the wider market growth rate and, despite having upbeat medium to long term prospects, the stock trades on a price to earnings (P/E) ratio of only 13. This indicates upward rerating potential which, alongside a yield of 4.3%, marks BAE out as a very appealing long term buy.
However, sector peer QinetiQ (LSE: QQ) could prove to be overvalued after having risen by up to 10% today. This rise follows an upbeat set of half year results which show that the company is performing relatively well in a tough trading environment, with both sales and profitability, as well as cash conversion, rising versus the comparable period last year.
The problem, though, is that QinetiQ’s valuation appears to take into account its future growth potential. For example, it trades on a P/E ratio of 16.3 and is expected to post net profit growth of just 2% in the current year, followed by further growth of 1% next year. And, with QinetiQ having a yield of 2.3%, it lacks income appeal, too. So, while its financial performance is on the up, it may be best to wait for a keener share price before buying a slice of it.
Meanwhile, Senior (LSE: SNR) issued a disappointing update today, with its main aerospace division seeing margins come under pressure. That’s because of costs associated with temporary activities to protect customer schedules as well as continuing declines in income received from machined waste aluminium. As such, Senior now expects profit for the full year to be at the lower end of guidance, although more positive news regarding orders from Boeing and Airbus has helped to push the company’s shares 3% higher in today’s trading session.
Also contributing to this rise is news of Senior’s acquisition of Steico for £49m and, with the company investing heavily in new equipment and new facilities, it remains confident of its long term prospects. And, with its shares trading on a P/E ratio of 12.6, it could begin to reverse the 13% decline in its share price experienced over the last year.
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Peter Stephens owns shares of BAE Systems. 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.