Image source: Rolls-Royce Holdings plc
Rolls-Royce Holdings The stock has been all over the headlines this year, with the price up 150% in the last 12 months. But does the valuation seem a bit exaggerated?
With a forecast price-to-earnings (P/E) ratio of 28, I think it could be. For now.
But I think other aerospace and defense actions have gone unnoticed. And I think that QinetiQ (LSE: QQ.) could be one of them.
Strong forecasts
Both companies have good forecasts for the coming years. And while I rate Rolls-Royce as a quality company for a long-term purchase, I'm more attracted to QinetiQ's valuation.
Forecasts put the P/E at 15, falling to 12 by 2026. Dividends are also expected to be a little better, between 2% and 2.5%, although it looks like Rolls might have some catching up to do.
On top of that, QinetiQ launched a new share buyback at the time of its third-quarter results in January.
Repurchase
CEO Steve Wadey said:Given the group's high cash generation and confidence in long-term prospects, we are pleased to announce the launch of a £100 million share buyback program to increase returns for shareholders, whilst maintaining capacity to implement our long-term growth strategy.“
We should have a fourth quarter update on April 16, with fiscal year results on May 23.
Defense boost
The human tragedy of global conflicts has been atrocious in recent years. But the Russian invasion of Ukraine has already led Western European countries to increase the level of their defense spending.
Even in the mid-term, QinetiQ recorded a 19% increase in orders, reaching a new record of £953 million. Half-year revenue was up 31% and underlying operating profit was up 35%. In organic terms, those gains were 19% and 25% respectively.
However, there is a danger here. If these provisional figures were not enough to increase the valuation much, what are investors worried about?
Cyclical risk
It could well be due to the cyclical nature of the business. When current orders are full, European states are reinforced to maximum defensive capacity, and the war is over, could companies like QinetiQ face a dry spell?
That's why I caution against relying too heavily on things like P/E measures for any industry that may experience large swings in demand.
I'm also a little wary of debt. And the balance sheet showed a small increase in the interim stage, to £273.8 million.
Still, in the January buyback announcement, the company said it has a net debt-to-EBITDA ratio of less than 1.5 times. So maybe I'm too worried, at least for now.
Diversification
If we think about Rolls-Royce, there is a more diverse business there. While QinetiQ relies on defense, Rolls is also big in civil aviation, power generation… and simply has its fingers in more business.
So there has to be more security there, and that could justify the higher valuation of Rolls-Royce shares.
But QinetiQ is definitely on my ISA shortlist. It's a pretty big list, bigger than my bank balance.
