For years, UK engineering giantsBAE Systems (LSE: BA) and Rolls-Royce Holdings (LSE: RR) were kings of the road. Investors thought they would motor on forever, butboth have stalled lately. Over the past five years, BAE has grown just 24%. The Rolls-Royce share price is up just 9%. Thesearent exactly car crash figures over the same period, the FTSE 100 rosea modest 11% but it isntsmooth motoring either.
You would have thought BAE Systems would be firing on all fronts, given todays political uncertainties, but cash-strapped Western countries have treated defence spending as if it was a luxury they could no longer afford. Given Chinas aggressive island-building spree in the South China Sea, Vladimir Putins manoeuvrings in the Crimea, Ukraine and now Syria, and Middle East chaos spreading into Europes neighbour Turkey, defence no longerlooks like a luxury.
Falling Back On Defence
The other problem is that the nature of warfare is changing. Allthe military hardware in the world couldnt tame Afghanistan and Iraq, and it probably wont help Putin save face inSyria, either. Aircraft, tanks, submarines, cruise missiles and nuclear warheads look increasingly obsolete, given that nation states darent use them against each other, and struggle to use them effectively againstterrorists.If cyber warfare is the future then BAE Systems still has a lot of catching up to do, although it is taking steps in this direction.
Still, BAE has had success selling kit for the European Typhoon, securing orders for Royal Navy Type 26frigates, and equippingourdelightfulally Saudi Arabia for its adventures in the Yemen.US defence spending is on course to rise next year.It is also doing better in commercial aerospace. Trading at just 12 times earnings and yielding 4.5%, it looks a solid buy for patient investors.
Rolling Backwards
Engineering giant Rolls-Royce is even cheaper than BAE, crashingto just 10.5 times earnings after a torrid six months thatsaw its share price fall 30%. Ithas issued four profit warnings since the start of last year, the most recent in July, on day twoof new chief executive Warren Easts tenure.
Rolls-Royce is yet another victim of the lower oil price. This has knockedorders at Rolls-Royces marine division, which supplies the offshore oil industry, and emerging market demand for jet engines. Defence cuts, a weaker global economy and Russian sanctions have added to the pressure. A scrapped share buyback,regularjob cuts and the companys arrogant attitude to communicating results suggestthat East has a tough job on his hands.
Despite the recent share price cash the yield remains disappointing at 3.3%, although handsomely covered 2.8 times it should at least be secure. Aforecast drop in earnings per share of 17% this year and 19% in 2016 suggests the turnaround will be slow. Butaircraft orders remain strong,its TotalCareaftermarket division powers on, and with some of the premium taken out of the share price, now may be the ideal time to bookyour seat before Rolls-Royce hits the road again.
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Harvey Jones 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.
