Defence stocks raided after US budget
The US defence budget for 2010 removes uncertainty surrounding the UK sector and prompts investor buying
The 2010 budget plan amounts to an overall increase in total expenditure of $11 billion or 2% to $667 billion, Numis Securities analyst Andrew Gollan said today, with be more money for the US Army and Marines and less for the Air Force and Navy.
Among the key takeaways from last night’s announcement is that production of the high profile F-22 Raptor advanced fighter will now end at 187 aircraft, Gollan said, while expenditure on the F-35 Joint Strike Fighter (JFS) will see a rapid ramp-up in commitment to build 513 aircraft over the next five years. For 2010, F-35 expenditure is to be raised to $11.2 billion from $6.8 billion in the previous budget or 30 aircraft versus 14 previously.
Blue-chip company BAE Systems builds the back end of the F-35 fighter here in Lancashire, Evolution Securities analyst Nick Cunningham pointed out this morning, which amounts to about 16% of the unit value and over 20% if you take into account that it also supplies a lot of the electronics in the aircraft. Fellow FTSE 100-member Cobham also provides a lot of the content on the F-35, Cunningham added.
Shares in the aerospace & defence space have been under substantial pressure in the lead up to yesterday’s budget announcement, with BAE having lost around a third of its market value amid anticipation of a pullback in US spending. Last night’s news, however, has seen the sector breathe a sigh of relief—on Wall Street overnight and in the UK this morning. “Overall the key takeaway from Gates’ speech is that it has largely ended uncertainty,” Cunningham wrote in a note to investors earlier today.
At last check, shares in BAE topped the FTSE 100 leaderboard, adding 5.8% to 347.5p, while Cobham followed in second place with a 2.7% rise to 181.3p. Though Cobham is set to benefit from the ramp-up in the F-35 programme, this effect is mitigated somewhat by the termination of F-22 production. However, Cobham is likely to benefit from increased spending in intelligence, surveillance and reconnaissance (ISR) and planned improvements in Cyberspace Security capabilities, Numis’ Gollan pointed out. Mid-cap QinetiQ Group is also likely to benefit from spending in these areas, Gollan added, but both QinetiQ and Cobham are exposed to missile defence where the budget it set to decline.
Other UK-listed companies to be impacted by the 2010 budget include Meggitt, Rolls-Royce Group and Ultra Electronics.
“With the positive portfolio effect of strong positions in areas where budgets are growing we think the overall picture for UK companies operating in the US defence market is robust,” Gollan concluded. “Indeed, we expect many to continue expanding in strategic sectors such as security and intelligence.”
Evolution’s Cunningham was similarly upbeat on the sector. He repeated his Buy recommendations on BAE, Cobham and Ultra, and respective price targets on the three stocks of 430p, 220p and 1,450p. Their current ratings are only just over half the normal rating for stocks that all offer double digit growth, strong cashflows, strong balance sheets (especially BAE and Ultra) and very good visibility—through 2015 in the case of BAE—Cunningham said. “The valuations have become, frankly, silly and we expect a strong rally,” he concluded.
In addition to BAE and Cobham’s share price hike this morning, Meggitt climbed up 0.9% to 145p and Ultra added 1.9% to 1,113p on the FTSE 250 index at last check. Fellow mid-cap stock QinetiQ lost 0.2% to 127.5p, however, while back on the lead index, Rolls-Royce slipped 1.8% to 319.75p.
