Today I’ll be examining the investment appeal of aero-engine maker Rolls-Royce and global information services group Experian. Should you be risking your money on either of these FTSE 100 giants right now, or are their valuations simply too steep?
Engine-maker under pressure
After a decade of continuous growth, aerospace and defence heavyweight Rolls-Royce (LSE: RR) suffered a turnaround in fortunes in 2014 when revenues fell by almost £1bn and pre-tax profits crumbled to just £67m from £2.8bn just two years earlier. Naturally, the firm’s share price has mirrored the company’s fortunes falling from highs of 1,270p at the start of 2014 to today’s levels around 770p.
The reversal of fortunes began in February 2014 when the company said that cuts in government defence spending would hinder full-year revenues, resulting in a sharp fall in the share price that hasn’t recovered in the three years since. More bad news was to follow with further profit warnings sending the shares closer to 500p earlier this year, a level not seen since the start of the decade.
Sadly, cuts in government spending haven’t been the only issue affecting the company’s bottom line, with the marine division suffering from a decrease in offshore oil and gas orders, and the all-important aerospace division also under considerable pressure. The City is estimating a £300m drop in revenues this year, with underlying profits predicted to be 56% lower than in 2015.
Rolls-Royce’s valuation looks increasingly inflated with the shares trading on a forward price-to-earnings ratio of 30, twice that of sector peer BAE Systems. I fear the shares could be heading for a massive market correction.
All-time high
Global information services supplier Experian (LSE: EXPN) has seen the value of its stock climb to all-time highs this year with the company’s shares now trading at a 45% premium to a year ago. The world’s largest credit-checking agency has enjoyed steady growth since joining the FTSE 100 in October 2006, expanding its geographical reach and making bolt-on acquisitions where appropriate.
Results for FY2016 were a little disappointing with negative earnings growth reported for the first time in eight years, and revenues $260m lower than in fiscal 2015. However, normal service should be resumed this year with a return to growth as analysts predict a 6% rise in underlying earnings for the current financial year to the end of March, with a further 8% improvement expected in the next year.
Despite the rosier outlook, I feel the steady single-digit earnings growth doesn’t fully justify the expensive-looking forward P/E rating of 22. In my view Experian looks overvalued at current levels, and now may not be the best time to buy the stock. That said, investors keen on the longer-term growth outlook may wish to pounce on any weakness in the share price and hence take advantage of a more favourable entry point.
