It’s been a disappointing year for investors in Rolls-Royce (LSE: RR), with the company’s share price falling by 20% since the turn of the year. This is considerably behind the FTSE 100‘s flat performance over the same time period. Indeed, while Rolls-Royce undoubtedly has products of the highest quality and a very strong brand, it could be left behind by aerospace and defence sector peers BAE (LSE: BA), Cobham (LSE: COB) and Meggitt (LSE: MGGT). Here’s why.
Differing Valuations
Of the four companies, BAE is priced the lowest. That may be because of a profit warning earlier in the year and the expectation that 2014 is set to be a rather disappointing year for the company. However, a price to earnings (P/E) ratio of 11.7 appears to be very attractive when you consider that BAE’s sector peers trade on far higher valuations.
For example, Cobham and Meggitt have P/Es of 14.8 and 14.3 respectively: both of which appear to be attractive (although to a lesser extent than BAE). However, Rolls-Royce, despite its 20% fall over the last eight months, is by far and away the most expensive of the four sector peers. It trades on a P/E of 15.8, which is considerably higher than the FTSE 100’s P/E of 13.7, too.
Growth Potential
Furthermore, Rolls-Royce does not seem to have significantly better growth prospects than its rivals, which could have been a reason for its higher rating. The company is forecast to post a fall in earnings of 2% this year, followed by a gain of 9% next year. Certainly, these are better figures than those of BAE, which is expected to see a decline in earnings of 11% this year and a rise of 4% next year. However, BAE’s P/E is 26% lower than that of Rolls-Royce, which appears to more than adequately price in a difficult year for BAE.
Furthermore, Cobham and Meggitt seem to have similar growth potential to Rolls-Royce. For example, while Cobham is expected to post a fall in profit of 7% this year, it is expected to bounce back next year with a rise of 11%. It’s a similar story at Meggitt, where earnings are set to fall by 13% this year and grow by 10% next year. So, while all four companies are due to have a tough 2014, Meggitt and Cobham could prove to have the stronger 2015, which could act as a catalyst on their share prices.
Looking Ahead
While Rolls-Royce is undoubtedly a high-quality company, its current valuation appears to be a little rich. Certainly, there is much better value on offer at BAE Systems which, although it has more pedestrian growth prospects, still seems to be well-positioned for the long-haul. Meanwhile, Cobham and Meggitt are cheaper than Rolls-Royce and their growth profile is broadly similar to their better-known sector peer. As a result, Rolls-Royce, while an attractive long term buy, could end up trailing its sector peers over the medium term.