On Monday (17 March), the share price of QinetiQ Group (LSE:QQ.), the FTSE 250 defence contractor, slumped nearly 21% after it issued a profit warning. Previously, it was predicting “high single digit organic revenue growth” for the year ending 31 March (FY25). Now, it’s expecting 2%.
To try and soften the blow for shareholders, the company unveiled an “extension to our share buyback programme of up to £200m over the next two years”. Following the announcement, this money will go a lot further. But I suspect it’s small comfort for investors.
Strong growth
Like many in the sector, the group’s grown in recent years. Comparing FY24 with FY20, revenue nearly doubled and underlying earnings per share increased by 47%. As a result, since March 2020, its share price has risen over 40%.
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However, it now appears as though this rapid growth has stalled. And at first glance, this doesn’t make sense. Recently, there have been many announcements from European countries promising to spend more on their armies, navies and air forces.
Last month, the UK pledged to increase spending to 2.5% of Gross Domestic Product, with effect from April 2027. Yesterday (18 March), Germany’s parliament voted to exempt military spending from its strict debt rules. And the European Union has announced plans that could see up to €800bn spent in the sector over the next four years.
Yet against this apparently positive backdrop, QinetiQ has issued a gloomy trading update. Could this be a warning for other defence stocks, whose share prices have done so well lately?
Troubled times
I’ve long thought that President Trump’s insistence that NATO members spend more on defence is a double-edged sword. As part of his ‘America First’ policy, he wants to stop subsidising the protection of other countries. This means the United States will end up spending less.
However, given the recent share price rallies of many in the sector, I suspect this hasn’t been factored in. Indeed, QinetiQ’s blaming many of its current problems on America. As a result of a restructuring in the country, the group expects to take a £140m hit to its bottom line. Monday’s press release also referred to “challenging US market conditions”.
However, it’s important to note that there’s always a time lag with defence contracts. It takes several years for the procurement process to conclude. With all investments it’s important to take a long-term view but, in my opinion, this is particularly good advice when it comes to defence stocks.
This could explain why QinetiQ remains positive. It says: “Longer term, the underlying strength of the Group coupled with the relevance of our mission critical capabilities to the national security needs of our customers in the UK, US and Australia as well as NATO allies, positions us well for long term future growth”.
However, I don’t want to invest in QinetiQ or the defence sector at the moment. There’s too much uncertainty for my liking. And generally speaking, in my view, valuations are on the high side.
It’s also important to acknowledge that, on ethical grounds, some are reluctant to buy into the sector. Having a smaller pool of potential investors could weigh on share prices over the longer term.
For these reasons, I’m going to look elsewhere for my next investment.
