Rolls-Royce Holdings shares have hit all the headlines this year, with the price up 150% in the past 12 months. Does the valuation look a bit toppy, though?
On a forecast price-to-earnings (P/E) ratio of 28, I think it just might be. At least for now.
But I think other aerospace and defence stocks have passed under the radar. And I reckon QinetiQ (LSE: QQ.) could be one of them.
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Strong forecasts
Both companies are on strong forecasts for the next few years. And while I do rate Rolls-Royce as a quality company for a long-term buy, I’m more drawn to the QinetiQ valuation.
Forecasts put the P/E at 15, and down to 12 by 2026. Dividends are expected to be a bit better too, at 2% to 2.5%, though it does look like Rolls should catch up.
On top of that, QinetiQ launched a new share buyback at Q3 results time in January.
Buyback
CEO Steve Wadey said: “Given the group’s high cash generation and confidence in the long-term outlook, we are pleased to announce the launch of a £100m share buyback programme to increase returns to shareholders, whilst maintaining the ability to deliver our long-term growth strategy.“
We should have a Q4 update on 16 April, with FY results on 23 May.
Defence boost
The human tragedy of world conflict has been appalling in recent years. But the Russian invasion of Ukraine has already led countries in Western Europe to raise the level of their defence spending.
Even at the interim stage, QinetiQ posted a 19% rise in orders, for a new record high of £953m. Revenue in the half rose by 31%, with underlying operating profit up 35%. On an organic basis, those gains were 19% and 25% respectively.
There is a danger here, though. If these interim figures weren’t enough to push the valuation up very far, what do investors worry about?
Cyclic risk
It could well be the cyclical nature of the business. When current orders are all filled, European states are beefed up to full defence strength, and the war ends, might firms like QinetiQ face a dry spell?
That’s why I’d caution against relying too much on things like P/E measures for any industry that can see big swings in demand.
I’m also a bit wary of debt. And the balance sheet showed a small rise at the halfway stage, to £273.8m.
Still, in January’s buyback announcement, the firm did say it has a net debt/EBITDA ratio of less than 1.5 times. So maybe I’m unduly concerned, at least for now.
Diversification
Thinking back to Rolls-Royce, there is a more diverse business there. While QinetiQ depends on defence, Rolls is also big in civil aviation, power generation… and just has its fingers in more pies.
So there’s got to be more safety there, and that might justify the higher valuation for Rolls-Royce shares.
But QinetiQ is definitely on my ISA candidates list. It is quite a big list, mind — bigger than my bank balance.
