Rolls-Royce (LSE: RR) is in the headlines today after its biggest shareholder, ValueAct, stated that it believes accelerated cost-cutting is the best way forward for the struggling engine and power systems manufacturer. Furthermore, ValueAct is apparently encouraging Rolls-Royce to consider a sale of its non-aircraft divisions that could leave a more streamlined, efficient and profitable business.
As a result of the comments, shares in Rolls-Royce have risen by over 4% today and are one of the top risers in the FTSE 100. However, they are still well down in the last three months, with Rolls-Royce seeing around 20% wiped off its valuation following a profit warning. And things could get worse before they get better for the company, with its bottom line set to fall by 17% in each of the next two years. Clearly, such figures would be likely to prompt a worsening of investor sentiment, so it seems obvious that the company’s new management team will need to take action.
Despite falling by a fifth in the last three months, shares in Rolls-Royce continue to trade on a relatively rich valuation. For example, they have a price to earnings (P/E) ratio of 14.6 and, factoring in next year’s planned fall in earnings, trade on a forward P/E ratio of 17.7. Rolls-Royce’s share price could under-perform the wider index until a clear and coherent strategy is announced and then begins to be delivered.
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A great value option
Of course, there are more appealing options in the FTSE 100. And, among industrial stocks, defence company, BAE (LSE: BA), stands out as a great value option. Like Rolls-Royce, it has had a profit warning in recent trading, but has recovered well so that it is expected to post earnings growth of around 6% next year.
Clearly, much of BAE’s recovery is due to a rapidly improving outlook for the defence sector, with an improving global economy meaning that defence budgets across the developed world are coming under less pressure.
However, BAE has also been able to improve its efficiency in recent years in response to weak demand for its products and, despite its upbeat outlook, trades on a P/E ratio of just 12.6. This indicates that there is considerable upside potential on offer.
Superb growth potential
However, an even better option than BAE is Unilever (LSE: ULVR). Certainly, it is a very different business than either BAE or Rolls-Royce, and its main advantage is that it is less dependent upon external factors than its two FTSE 100 peers. In fact, Unilever has a much more reliable earnings outlook, with a high degree of customer loyalty for its products ensuring that, even if the global economy experiences a downturn, sales of Unilever’s goods should remain buoyant.
Unlike BAE, however, Unilever trades on a high P/E ratio of 22.5, so there is less scope for an upward re-rating than its index peer. Unilever, though, has superb growth potential, with its bottom line set to rise by 14% this year and by a further 7% next year. As such, investor sentiment could be positively catalysed and push the company’s share price to higher highs.
And, while BAE is a great stock, if you could only buy one or the other, then Unilever’s defensive attributes make it the preferred choice at the present time.
