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April was the cruellest month for BAE Systems (LSE: BA.) shares. After a terrific run, they slumped 12.5%. The same goes for another FTSE 100 defence stock, Babcock International Group (LSE: BAB). It plunged 14.8% last month. What on earth’s going on?
These companies make weapons. Fighters, destroyers, submarines, munitions, drones and much more besides. As geopolitical tensions rise by the day, their products are in demand. Both have massive order backlogs, more than £80bn in the case of BAE Systems, and around £10bn for Babcock, which is the smaller player. This gives them terrific long-term earnings visibility.
So why did these shares suddenly slump last month?
Whatâs gone wrong with defence stocks?
Rolls-Royce (LSE: RR) is a more complex case. It has a Defence division, but it’s main line of business is building and maintaining aircraft engines, while it also has big opportunities in power plants, data centres and small modular reactors, or mini-nukes. Yesterday (30 April), Rolls posted a terrific set of Q1 results. Its Civil Aerospace and Power Systems divisions grew strongly, while Defence posted a 20%+ increase in new equipment sales. The shares jumped 7.6% on the day, but Rolls-Royce still ended April down 7.56%.
As a benchmark, the FTSE 100 ended April roughly where it began. We can’t blame the defence stock slump on a wider downturn. So what can we blame?
This might be a case of investors buying the rumour, and selling the fact. Investors are forward looking. Now that war is staring us in the face, they’re looking for the next big opportunity. Also, the stocks have become expensive. The price-to-earnings ratios for BAE Systems and Babcock have nudged 30 in recent months. At one point, Rolls-Royce topped 60. Even after recent turbulence, their P/Es still look somewhat stretched:
- Babcock P/E: 26.9
- BAE Systems P/E: 28.1
- Rolls-Royce P/E: 44.4
These two factors may partly explain what’s going on. Also, many investors will be taking profits, and they will be big profits too. Just look at their five-year performance figures:
- Babcock: 280%
- BAE Systems: 298%
- Rolls-Royce P/E ratio: 958%
Are we looking at a brilliant buying opportunity?
Incredibly, these stellar numbers are after their recent share price slips. Personally, I think it’s pretty clear what we’re looking at here. A good old-fashioned buying opportunity for long-term investors.
Defence stocks were due a bit of a breather. No share or sector rises in a straight line. Investors may also be concerned that European countries won’t step up to the plate and spend more on defence, especially the UK.
I’m still worried about those valuations. There’s scope for further slippage if results disappoint. But investors who feel they don’t have enough exposure to the defence sector, or felt they’d missed out on the action, may now have the moment they were waiting for.
That doesn’t mean defence won’t fall further over the summer. But in my view, the buying opportunity is already upon us and worth considering.
The post What on earth’s happening to Babcock, Rolls-Royce and BAE Systems shares? appeared first on The Motley Fool UK.
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Harvey Jones has positions in BAE Systems and Rolls-Royce Plc. The Motley Fool UK has recommended BAE Systems and Rolls-Royce Plc. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.
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