Why this FTSE 250 engineer could be a better buy than BAE Systems plc

Roland Head explains why he believes this FTSE 250 (INDEXFTSE:MCX) stock could outperform BAE Systems plc (LON:BA).

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Shares of FTSE 250 component manufacturer Rotork (LSE: ROR) rose by as much as 4% when markets opened on Monday morning, despite the company admitting that pre-tax profit fell by 10.6% to £91.1m last year.

In this piece I’ll explain why I think Rotork shares could have further to rise, and why this stock could be a better buy than FTSE 100 peer, BAE Systems (LSE: BA).

A solid set of figures

The oil and gas industry accounted for 52.4% of Rotork’s revenue last year. A subdued performance was always likely, given the scale of the downturn in this sector.

Should you invest £1,000 in BAE Systems right now?

When investing expert Mark Rogers has a stock tip, it can pay to listen. After all, the flagship Motley Fool Share Advisor newsletter he has run for nearly a decade has provided thousands of paying members with top stock recommendations from the UK and US markets. And right now, Mark thinks there are 6 standout stocks that investors should consider buying. Want to see if BAE Systems made the list?

See the 6 stocks

However, last year’s performance was far from bad. Including acquisitions and currency effects, Rotork’s sales rose by 8% to £590.1m. The group’s order intake was 9.6% higher. To help protect profit margins, Rotork’s management made cost savings worth £6.6m, offsetting the impact of weaker pricing in some areas.

The overall result was that adjusted earnings fell by 3.8% to 10p per share in 2016, slightly ahead of consensus forecasts of 9.65p per share. The full-year dividend was increased by 1% to 5.1p per share, giving the stock a trailing yield of 2.1%

A superior business?

It’s worth pointing out that Rotork’s adjusted operating margin of 20.4% is significantly higher than the equivalent figure for BAE Systems, which is about 10%. Sales growth at the smaller firm has also been much stronger in recent years.

Rotork’s revenue has risen by an average of 7.5% per year since 2010, when the firm reported sales of just £380.6m. In contrast, BAE’s 2016 revenue of £17,790m was broadly unchanged on the group’s 2011 figure of £17,770m.

Rotork has achieved this growth without sacrificing the strength of its balance sheet. Strong cash generation enabled the group to reduce its net debt by £16.2m to £55m last year, despite spending £16.3m on the acquisition of Mastergear. The group’s net debt equates to less than one year’s net profit, so is very modest and definitely not a concern for investors.

BAE’s debt levels aren’t a concern either, but the defence group’s £6.1bn pension deficit might be. It represents 6.5 times last year’s net profit of £938m and currently requires deficit reduction payments of more than £400m per year.

My choice to buy

In general, I rate BAE Systems as an attractive long-term income buy. I hold it in my own portfolio for this reason. But the defence group’s shares are currently trading at all-time highs. I’m not convinced now is the right time to buy.

Although BAE’s forecast P/E of 14 and prospective yield of 3.6% seem fairly affordable, the firm’s growth rate seems likely to remain fairly pedestrian. I suspect that investors buying at this level will be unlikely to beat the wider market.

Rotork shares also look fully priced, on 22.8 times 2017 forecast earnings. The firm’s yield of 2.2% is below the FTSE 250 average of 2.7% and may not attract many income investors.

However, Rotork has a track record of growth and should benefit from the continuing recovery in the oil market. I believe this FTSE 250 stock is more likely than BAE to beat expectations over the next couple of years, despite its strong valuation.

Should you buy BAE Systems now?

Don’t make any big decisions yet.

Because Mark Rogers — The Motley Fool UK’s Director of Investing — has revealed 5 Shares for the Future of Energy.

And he believes they could bring spectacular returns over the next decade.

Since the war in Ukraine, nations everywhere are scrambling for energy independence, he says. Meanwhile, they’re hellbent on achieving net zero emissions. No guarantees, but history shows...

When such enormous changes hit a big industry, informed investors can potentially get rich.

So, with his new report, Mark’s aiming to put more investors in this enviable position.

Click the button below to find out how you can get your hands on the full report now, and as a thank you for your interest, we’ll send you one of the five picks — absolutely free!

Grab your FREE Energy recommendation now

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head owns shares of BAE Systems. The Motley Fool UK has recommended Rotork. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Investing Articles

Prediction: 12 months from now, £5,000 invested in Tesla stock could be worth…

Tesla stock has endured a miserable year so far, falling by 29%. Muhammad Cheema takes a look at how it…

Read more »

Investing Articles

See what £10,000 invested in Tesla shares at their mid-December peak is worth today 

As the world absorbs the full scale of Donald Trump's tariffs, Tesla shares are reeling. Investors who bought the stock…

Read more »

Hand flipping wooden cubes for change wording" Panic " to " Calm".
Dividend Shares

2 ‘safe’ LSE dividend stocks to consider as global markets sell off

As global markets experience high levels of volatility due to economic uncertainty, investors are piling into these ‘safe-haven’ dividend stocks.

Read more »

Investing Articles

US stock market rout: an unmissable opportunity for investors?

His tech-heavy portfolio has been smashed by Trump’s tariffs. However, Dr James Fox believes there could be some opportunities in…

Read more »

Investing Articles

After a 13% ‘Trump tariff’ fall, is the Barclays share price too cheap to miss?

Does the Barclays share price fall mean we should all panic and run screaming from the stock market? Nah, of…

Read more »

Mature Caucasian woman sat at a table with coffee and laptop while making notes on paper
Investing Articles

2 investment trusts to consider for a Stocks and Shares ISA

These two investment trusts have a different focus -- but our writer sees both as worth considering, one more for…

Read more »

Investing Articles

Deutsche Bank reiterates Buy rating on 9.6% yielding FTSE 250 stock that was “most shorted in UK”

Our writer investigates why a major broker remains optimistic about a FTSE 250 stock that was once the most shorted…

Read more »

Investing Articles

2 things to remember when stock markets are turbulent

US trade policy has rattled the stock markets in New York, London and elsewhere. Our writer outlines a couple of…

Read more »