Despite jumping 6% on news of a buy-back, shares in aircraft brake-manufacturer Meggitt (LSE: MGGT) are still down nearly 12% since the start of the year, underperforming the FTSE 100s 4% drop. Meggitts stock has shared the same fate as its bigger aerospace peer, engine-maker Rolls-Royce (LSE: RR), which is down 34%.
Both companies have issued profits warnings this year and both are, in their way, shrinking. Rolls has announced a programme to slash 2,600 jobs, 5% of its global workforce. Meggitts buy-back is tacit acknowledgement that, with a strong balance sheet, returning cash to shareholders is preferable to the investment and acquisition opportunities available. Cutbacks in defence spending are at the heart of both companies woes. Both have also struggled in the energy sector where they sought to diversify, Rolls explicitly citing the indirect impact on the sector of trade sanctions against Russia.
So this is bad news for investors? Well, not necessarily. Its not too much of a leap of faith to see both companies travails as transient, with the long-term investment case intact. That could present an attractive buying opportunity.
There are three fundamentals that underpin the long-term appeal of both Rolls and Meggitt:
- They are in robust markets. Civilian aerospace is on a trajectory of growth as rising affluence in the worlds population fuels long-distance travel whilst airlines are investing in more efficient fleets. Western defence spending is sure to rebound someday, with the success of the Republican Party in Congressional elections likely to accelerate it;
- Both companies have strong economic moats, based on engineering expertise and established user bases. Rolls is one of three world-class engine makers. Meggitt operates in a smaller niche and the company is smaller. But what it loses in scale it gains in attractiveness as a bid target: why replicate its technology when you could buy the company?
- Both companies earn substantial revenue from after-sales services. That boosts earnings visibility, cushions against cyclical downturns, and closely integrates the companies into their customers supply chains.
Shares in Rolls and Meggitt are trading on prospective PEs of 13.1 and 13.6 respectively, with yields of 2.8% and 3.1% though analysts will be re-working Meggitts numbers to account for lowered guidance next year, offset by the reduced number of shares in issue after the buy-back.
Those numbers are pretty close to the market average but the fundamentals of these companies make them far superior to the average and they have often traded at higher ratings. Indeed a blog post about Rolls share price slide on the website of the popular and respected Woodford Fund spells it out: As long-term investors, this is exactly the sort of market inefficiency that we aim to exploit the market is focusing on the short-term disappointment, whereas we look beyond this to assess the long-term opportunity. Rolls is Woodfords tenth-largest holding.
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Tony Reading owns shares in Rolls-Royce and Meggitt. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.