Which Footsie engineer is today’s sector best buy?

Shares in high-profile aero engine firm Rolls-Royce Holding (LSE: RR) have made a strong recovery from their January lows, but are still worth 2% less than they were a year ago.

Meanwhile GKN (LSE: GKN) has plodded onwards and delivered a 12% gain over the last 12 months, beating both the FTSE 100 and Rolls-Royce. And the contrast in performance is even greater over the last five years.

5-year performance



Share price gain



Dividend growth



However, Rolls-Royce appears to be on the road to recovery in the hands of ex-ARM Holdings boss Warren East and the outlook for GKN is more measured.

Should investors consider switching out of GKN and into Rolls-Royce?

Don’t underestimate GKN

GKN’s acquisitions of Volvo Aero and Fokker have helped the group expand its market share in the aviation market over the last few years. Its focus on aviation and the automotive market has served GKN well, as it’s been able to avoid the slowdown in the oil and gas sector.

Sales rose by 17% to £4,518m during the first half of the year, with adjusted operating profit 13% higher at £390m. Adjusted earnings rose by 7% to 15.5p, suggesting that GKN is on track to meet full-year forecasts of 28.7p.

On the other hand, GKN doesn’t seem to be as profitable as it used to be. The firm’s statutory operating margin has fallen from a peak of 9.6% in 2012 to just 4.5% last year. This has caused return on capital employed — an indicator of long-term returns — to fall from 13.7% in 2012 to 6.1% in 2015.

A second risk is that GKN’s pension deficit rose by 35% to £2,101m during the first half. Management expects current deficit payments of £42m per year to rise, which could limit dividend growth.

However, GKN expects to deliver further growth in most key markets this year. The shares trade on a modest forecast P/E of 11 and offer a prospective yield of 2.8%. I believe GKN remains a decent long-term buy.

Can glamour stock Rolls fight back?

Rolls-Royce had a pretty glamorous reputation for an engineering business. Before profits started to crumble in 2014, the stock traded on a steep valuation and attracted high-profile investors such as Neil Woodford.

The situation is rather different today. Exposure to the oil and gas sector and complicated accounting have helped to deflate the share price. Mr Woodford has long since sold his funds’ shares in the group.

But things are improving. Chief executive Warren East is cutting costs and thinning out management ranks to create a more focused and efficient business. Mr East has cut the dividend and confirmed that the full-year trading outlook is unchanged.

Investors have responded enthusiastically and Roll-Royce shares have risen by 24% since 1 January. But these gains have left the firm trading on 28 times 2016 forecast earnings, falling to a forecast P/E of 22 for 2017.

In my view, a substantial level of recovery has already been priced-in. We also don’t yet know the answers to some of the questions surrounding the group’s historic revenue recognition policies. I’m not sure the shares are cheap enough to be worth buying at this stage in the group’s turnaround, so I’d rate them as a hold.

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Roland Head has no position in any shares mentioned. The Motley Fool UK owns shares of GKN. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.