As geopolitical tensions rise in Europe and the Middle East, UK shares in the defence industry are on my radar.
Increased threats to Europe have sent defence budgets soaring. Both large and small UK companies are stepping up to provide arms, intelligence and cyber defence technology. It’s common knowledge that BAE Systems and Rolls-Royce have done well lately, but they’re not the only UK defence stocks.
I’m evaluating three lesser-known defence shares worth considering in 2024.
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Babcock International
Babcock International (LSE:BAB) provides engineering support and product development for land, marine, nuclear and aviation operations globally. It also builds and decommissions nuclear facilities in the UK, including submarines. As owner and manager of two UK naval bases, it’s well established in the defence sector, providing naval and military support to Ukraine.
With an acceptable balance sheet, I would keep an eye on its debt. With over £1bn in debt and only £354m in equity reported in 2023, its debt-to-equity ratio is high at 2.67. The share price is up 72% this year but fell sharply during Covid and is still down 20% since early 2020. Subsequently, consensus among analysts estimates the shares to be undervalued by 27%.
I believe the price has good growth potential from here as it’s a reliable stock with strong ties to the global defence industry.
Serco Group
Serco Group (LSE:SRP) is involved in defence, immigration, transport and justice in the UK and mainland Europe, with additional operations in the Middle East, Australia, Hong Kong and North America. As a designer and producer of critical defence assets, it plays a key role in European defence operations. It also provides engineering, infrastructure support and training to military personnel.
In its 2023 full-year report, revenue was up 7.5% and earnings per share (EPS) up 36%, exceeding analyst expectations. At £1.84, the share price is estimated to be trading at fair value compared to peers and industry.
So why did employees Nigel Crossley and Mark Irwin collectively sell £920k worth of their shares this past week? Possibly because revenue is forecast to decline in the coming years due to government efforts to reduce spending on asylum seekers, combined with the renewal of a five-year Medicare contract.
Subsequently, the forward-looking price-to-earnings (P/E) ratio is 13.5 (up from 9.9), potentially limiting future price growth. Still, there’s general agreement among analysts that the price will increase by around 20% in the coming year.
QinetiQ
QinetiQ (LSE:QQ.) develops advanced technology to aid military operations. Some of its services include AI, cybersecurity, naval control systems, radar enhancement, robotics, and missile detection.
The share price has been rather subdued lately, down 4.5% in the past year, with profit margins cut in half. In first half 2024 earnings report, EPS missed analyst expectations by 7.6%. With a heavy reliance on government defence spending, any reduction there puts QinetiQ’s profits at risk — particularly considering the highly specific, cutting-edge nature of its products.
But with income and revenue up, the price seems to be lagging behind. Subsequently, QinetiQ shares could be selling cheap at £3.52. Future cash flow analysis estimates a fair price to be more in the range of £6.50. This is backed by forecasts from eight analysts with consensus on a 12-month price target of around £4.33 – a 23% increase.
