Rolls-Royce Holding (LSE: RR), Meggitt (LSE: MGGT) and GKN (LSE: GKN) have all underperformed the FTSE 100 by a large margin so far this year:
|
2014 YTD performance |
|
|
FTSE 100 |
-4% |
|
Meggitt |
-18% |
|
GKN |
-21% |
|
Rolls-Royce |
-26% |
However, such a short-term view disguises the fact that over the last five years, all three of these firms have significantly outperformed the wider index Rolls-Royce, for example, has gained 108% since 2009, compared to just 30% for the FTSE 100.
Given this, Ive been wondering whether this years weakness could be a good opportunity to buy into these quality businesses, rather than a cause for concern.
A rare opportunity?
Lets start with a look at the forecast valuations of each of these firms:
|
2014 |
Rolls-Royce |
Meggitt |
GKN |
|
Forecast P/E |
14.5 |
13.3 |
10.5 |
|
Prospective yield |
2.5% |
3.1% |
2.9% |
|
2015 |
|||
|
Forecast P/E |
13.4 |
12.1 |
9.8 |
|
Prospective yield |
2.7% |
3.4% |
3.1% |
All three of these firms offers a below-average yield, but all three are expected to increase their dividends by around 6% in 2014 and 8% in 2015 faster than the market average.
Is the outlook rosy?
Of course, its possible that this years underperformance is the start of a longer-running slump, which will bring their long-term gains closer to those of the FTSE 100, a process investors refer to as mean reversion.
Is this likely? I believe all three of these companies are high quality businesses with competitive advantages that should protect them from a protracted slump, but there have been a few warning flags so far this year.
Rolls-Royce: In its interim results, Rolls reported a 7% fall in underlying revenue and a 20% fall in underlying profits. The firms order book shrunk by 2% and chief executive John Rishton said that Rolls will experience growing pains.
Meggitt: First-half revenue fell by 3%, with underlying operating profit down by 17%. It did, however, manage to grow its order book by 9%, and like Rolls-Royce, expects to have a stronger second half.
GKN: GKNs exposure to the automobile sector gives it a slightly different outlook to the other two firms, and this helped drive 6% growth in pre-tax profits during the first half of this year, underpinning strong free cash flow.
Three to buy?
Although all three face headwinds from declining military spending, I think that much of this risk has already been factored into current valuations. Currency headwinds are now starting to reverse, and this should help offset weaker military sales.
Overall, I think that all three of these firms look attractive long-term buys, although further research would be required to make a final selection.
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Roland Head has no position in any shares mentioned. 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.
