The aerospace industry was squeezed by the recession, but BAE Systems (LSE: BA)(NASDAQOTH: BAESY.US) managed to pretty much shrug it off thanks to its big overseas sales, principally to Saudi Arabia. Earnings have been up and down a bit, mainly due to the nature of payments for multi-year projects, but they’ve been steady.
Rolls-Royce Holdings (LSE: RR)(NASDAQOTH: RYCEY.US), on the other hand, shocked the world with a couple of profits warnings in 2014, telling us it doesn’t expect to see earnings returning to growth until at least 2016. That did give the markets a bit of a fright, and the share price is down 24% over the past 12 months to 913p — compared to a 19% rise to 521p for BAE.
Earnings set to fall
We have full-year results from Rolls due on Friday 13th, so will they provide the kickstart needed to get the company back to its former reliable health?
We’ve had some cost-cutting and the offloading of some business, and an interim update in November told us that restructuring charges are likely to knock around £60m per year off underlying profit in 2014 and 2015. October’s guidance was reiterated, and that suggested a 3.5% to 4% fall in 2014 revenue compared to 2013. Free cash flow should also drop significantly, from 2013’s figure of £780m to around £350m.
With the detailed level of guidance given by Rolls, there are unlikely to be any surprises when we get the results on Friday. Analysts are currently predicting a 4% fall in EPS followed by something similar in 2015, giving us P/E ratings of 14.3 and 14.8 respectively.
So are we looking at a bargain situation after the share price fall?
A change in sentiment
Well, Rolls Royce shares have commanded higher P/E ratings than BAE in past years, and that’s come largely from the generally strong sentiment surrounding what has been seen as a superior company that doesn’t see sales falling and just does not issue profit warnings. But that myth has been shattered now, and we may well be looking at a long-term rerating of the two companies’ relative valuations.
BAE shares are on a lower forward P/E multiple, of around 13. And, crucially, BAE is offering superior dividends — there’s a yield of 3.9% expected for 2014 rising to 4.1% in 2015, compared to just 2.5% and 2.6% from Rolls for the same two years. Granted, Rolls’ dividend should be better covered, but the company has been paying lower-than-average yields for some years now with the shares on higher-than-average valuations.
Which is better?
It looks like Rolls-Royce still has a couple of years of work ahead of it to get back on track for earnings growth, and even after the stronger share price performance I still think BAE is looking better value.