Shares in GKN (LSE: GKN) and Meggitt (LSE: MGGT) moved in opposite directions this morning after both engineers published their 2015 results.
Both companies are popular choices for income investors, as is Meggitt’s larger defence peer, BAE Systems (LSE: BA). We’ve now seen last year’s results from all three firms. Which one looks the best income buy?
GKN
GKN has customers in the aerospace, automotive and heavy plant sectors. This diverse customer base helped GKN to generate a 3% increase in sales and an 11% rise in reported pre-tax profits of £245m in 2015, despite the impact of the mining downturn.
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I chose to mention reported pre-tax profits above because I’m a little concerned about the level of adjustment GKN uses to generate its “management basis” adjusted profits. Adjusted pre-tax profit was £603m in 2015 — 146% more than reported pre-tax profit of £245m. The figures were similar in 2014.
Relying on the adjusted earnings per share of 27.8p gives GKN stock a trailing P/E of 10, which seems cheap. Using last year’s reported earnings per share of 11.8p gives a P/E of 24, which isn’t.
GKN’s free cash flow was £370m in 2015. Removing a one-off customer advance payment of £115m gives a figure of £255m. For this reason, I’d argue that GKN’s reported pre-tax profit of £245m is probably a more realistic view of actual cash profits than the adjusted figure of £603m.
Reported earnings of 11.8p per share only give dividend cover of 1.4 times, slightly lower than I like to see. While I think GKN is a good business, I’m not convinced it’s a great dividend stock or particularly cheap.
Meggitt
Defence firm Meggitt also reported full-year results today. The group’s underlying earnings per share fell by 2% to 31.6p, while reported earnings per share actually rose by 5% to 23.2p. Meggitt’s full-year dividend rose by 5% to 14.4p.
One fly in the ointment was that net debt rose by 83% to £1,053.1m. However, this was mostly the result of acquisitions. Meggitt’s debt level remains comfortably within its lending covenants. Last year’s cash flow suggests to me that net debt should come down a little this year. I’d certainly hope to see this.
Although conditions are improving in defence markets, Meggitt only expects low single-digit percentage growth this year. The firm says that seeing cash flow from recent US military budget increases may take “some time”. With a trailing yield of 3.5% and a P/E of 12.9, I’d argue that Meggitt shares are fairly valued and a hold for income.
Is BAE a better buy?
BAE’s 2015 results revealed a 7.6% rise in sales and a 15.5% increase in operating profit. A 2% dividend increase to 20.9p gives the shares a trailing yield of 4.1%.
The firm’s guidance is for adjusted earnings growth of 5% to 10% in 2016, as sales are expected to rise in the firm’s Electronic Systems and Cyber Intelligence divisions. The latest consensus forecasts suggest adjusted earnings of 39.3p per share for this year and a 3% dividend increase. This gives a forecast P/E of 13 and a potential yield of 4.2%.
BAE’s balance sheet remains relatively strong and the firm’s outlook appears to be improving more quickly than either GKN or Meggitt. I rate BAE as a good long-term income buy.
