Since reaching a share price of 675p in July 2018, BAE (LSE: BA) has declined by 27% to trade at its current level of around 496p. As well as a decline for the wider FTSE 100, the stock has been hurt by continued geopolitical uncertainty regarding its key customer, Saudi Arabia.
While this could mean there are challenges ahead for the company, its low valuation and the growth potential offered by the wider defence sector could lead to a share price recovery. As such, it could be worth buying alongside another potential turnaround play that released a trading update on Tuesday.
Improving prospects
The stock in question is corrugated and plastic packaging specialist DS Smith (LSE: SMDS). Its trading update for the 2019 financial year showed it’s performed in line with expectations. It has seen further growth in corrugated box volumes and market share gains, driven by its strong position in the e-commerce packaging market.
There’s been strong growth in the UK, Italy and Poland, while all the company’s regions have delivered growth. It expects to make further progress on margins, while its US business is beating expectations following its acquisition. Further M&A activity has the potential to improve its efficiency, as well as deliver stronger profit growth over the medium term.
With DS Smith’s share price having declined by 27% in the last year, it now has a price-to-earnings growth (PEG) ratio of 1.7. This indicates it offers good value for money, given that it’s delivered positive earnings growth in each of the last five years. Therefore, a recovery could be ahead for the company over the long run.
Low valuation
While BAE has highlighted the potential for difficulties in servicing demand from Saudi Arabia as a result of geopolitical challenges, the company is expected to post a rise in earnings of 9% in the current year. After its share price fall, it trades on a price-to-earnings (P/E) ratio of just 10.6, which suggests it has a wide margin of safety when its forecast growth rate is taken into account.
The defence industry is expected to experience a period of intense growth over the medium term. A robust outlook for the world economy, coupled with continued geopolitical risks across a variety of regions, means defence spending may experience an upturn after a period of slow growth in response to he impact of the financial crisis.
With the company having a large backlog of orders, as well as major customers other than Saudi Arabia, its financial outlook may be more robust than the stock market is currently pricing in. As such, there could be an opportunity for value investors to buy shares in BAE at a time when it seems to be trading significantly below its intrinsic value.
