War keeps making headlines and people holding the purse strings, including Grant Shapps, the defence secretary, say that more conflict is on the horizon. You would assume by now that there was no value left in defence stocks, but fortunately the market isn’t that efficient. Qinetiq stands to benefit, but has been largely shunned by investors.
The former government research agency helps its clients to create, test and use new and existing defence products. It stands out from its London-listed peer group in several ways, including by focusing more on new technologies, such as battlefield robots and unmanned aircraft, rather than on traditional military hardware. Normally, being ahead of the curve is rewarded. Not this time.
Slower growth in the United States than had been expected is mainly to blame for the poor sentiment. Qinetiq has made no secret of its desire to expand in this key defence market, but delivering on that objective hasn’t always been smooth sailing.
The company attributed the slow start of Avantus Federal — a Virginia-based business with expertise in cyber and data analytics that it bought for big bucks in 2022 — to American budget delays. Contracts are being won, but later than anticipated because of political wrangling over record high defence spending.
Its defence sector peers also have flagged this issue, suggesting that Qinetiq isn’t to blame for booking lower revenue than forecast, but investors are hesitant, perhaps because they haven’t forgotten past hiccups. This isn’t the first time that the FTSE 250 group has encountered problems in the competitive US market.
Setbacks across the pond and a lack of suitable acquisition targets could derail Qinetiq’s ambitious target to nearly double its revenue by March 2027. For now, it means the defence contractor, which for years has been aiming to become more international, remains heavily exposed to Britain. The group’s much smaller home market still accounts for two thirds of its turnover.
Caution is warranted, but the punishment dished out is a little on the harsh side. Qinetiq trades on a forward earnings multiple of 11 times, about 22 per cent below its historic average and at least 35 per cent less than BAE Systems and Chemring, other sector players with a more global focus.
Qinetiq isn’t a laggard. Over the past four years, its revenue and profit have expanded at a compound annual growth rate of 15 per cent and 9 per cent, respectively. The contractor has a long track record of good cash generation, supported by disciplined working capital management, double-digit underlying operating margins and a sector-leading return on capital.
Its growth prospects aren’t bad, either. Qinetiq’s three core markets of Britain, America and Australia are all pledging to spend record amounts on defence as global political tensions rise. And their priorities are shifting increasingly away from boots-on-the-ground warfare to modern methods that rely less on humans and more on technology, areas where Qinetiq excels. When looked at that way, the target to reach £2.4 billion in revenue, or £3 billion if enough acquisitions are made, at a 12 per cent margin in just over three years doesn’t sound so far-fetched.
Returns also should be boosted by reducing the share count. This week the group said it had struggled to find suitable acquisition targets and, therefore, would put its cash to use repurchasing company stock. A total of £100 million has been put aside for this task, which analysts at Shore Capital believe will boost earnings per share by about 5 per cent. It’s comforting to know the company is being picky with acquisitions and is deploying its capital wisely.
Qinetiq doesn’t deserve to trade at such a wide discount to its long-running average or peer group. The present rating suggests that investors are fixating on the negatives and are not expecting much positive news. That seems a foolish stance to take against an altogether well-run company with a desirable niche in matters of national security.
Advice Buy
Why The shares are undervalued
Page Group
It has been an eventful week for Page Group. On Monday, the international recruiter of specialist, generally white-collar staff was forced to downgrade its profit expectations. Then, on Wednesday, hopes of a swift economic recovery were dashed slightly by another reminder that inflation isn’t budging and that interest rates may remain elevated for longer than anticipated.
Economic uncertainty usually prompts businesses to cut back on hiring and candidates to stay put. Page is particularly vulnerable because about three quarters of its gross profit comes from placing job-seekers in permanent positions. In times like this, temporary solutions are generally more highly sought after.
Monday’s fourth-quarter trading update provided ample evidence of these issues. Less job movement, triggered by tightening employer budgets and shaky confidence, spurred a steep drop in Page’s gross profit, causing it to slightly miss its annual guidance.
Most investors weren’t surprised by this downturn. It was inevitable that eventually a prolonged period of high interest rates would sting and Hays and Robert Walters, the rival recruiters, mentioned similar challenges the week before. When the response to a profit warning is indifferent, you can assume it was expected.
With the bad news out the way, the focus moves to the positives. And there are a few things that provide reassurance. Page specialises in highly skilled candidates that are hard to find and in hot demand, is set up in a way that staff numbers and its cost base are easily adaptable, pays an attractive dividend that’s supported by a healthy balance sheet and serves a range of sectors and almost every corner of the planet. This implies the recruiter is capable of weathering a storm. It also explains why there hasn’t been a big exodus.
Since the end of October 2023, investors have been piling in to pick up the dividend and wait for a turnaround. Consequently, the shares now trade at 17.5 times forecast earnings, which could be considered steep, especially if interest rates don’t fall as quickly as expected.
Advice Avoid
Why The turnaround could take longer than anticipated to materialise
