With European military spending set to soar in the years ahead, defence stocks have been on fire. BAE Systems, from the blue-chip FTSE 100 index, is up 41% in three months, while the FTSE 250‘s Babcock International has rocketed 50% over that time.
Unfortunately, shares of QinetiQ Group (LSE: QQ) haven’t kept pace. In fact, they’ve crashed 27% in just the past three days!
Now, I’m bullish on European defence stocks. It’s hard not to be when Germany has just voted to massively increase its military budget in response to wavering US commitment to European security.
So, is this an opportunity to add QinetiQ shares to my portfolio? Let’s take a look.
What’s happened here?
The chief culprit for the stock’s recent slump was a trading update released on 17 March. In this, the company warned that “tough market” conditions would impact its financials for the full year ending 31 March.
Specifically, there have been delays to a number of contracts being awarded in the US and UK. Also, it said “recent geopolitical uncertainty has impacted our usual fourth quarter weighting to higher margin product sales from the US”.
As a result, QinetiQ expects full-year organic revenue growth of about 2%, roughly £1.95bn in total revenue. That was lower than the £2.04bn analysts had pencilled in.
Meanwhile, the firm is restructuring its US business to support future growth, which will result in a £140m impairment charge. Additionally, there were £35m-£40m in one-off, non-cash charges, mainly in legacy US operations.
For next year, the company is guiding for revenue growth of about 3%-5%, with an underlying profit margin of 11%-12%. That growth figure is also lower than previously expected.
Some good bits
On a more positive note, its UK Defence Sector business (50% of group revenue) continues to perform well due to long-term contracts. And it announced a share buyback programme of up to £200m over two years, starting in May.
The stock now looks quite cheap. It’s trading at about 13 times expected earnings for 2025, while offering a 2.3% dividend yield. That’s a significant discount to other defence stocks.
Plus, the firm still sees solid long-term growth opportunities ahead: “Within the evolving threat environment, our customers’ spending priorities, which are well matched to our capabilities, have been boosted by commitments to increased spending in the UK and Europe.”
Looking ahead to the next few years, there is every chance that the firm secures a flurry of defence contracts in the UK and Europe. That could spark a turnaround in investor sentiment.
Should I buy QinetiQ stock?
QinetiQ generates most of its revenue from the UK. The government plans to increase defence spending to 2.5% of GDP by April 2027, up from the current 2.3%. It might even go higher, but money is tight and there will have to be cuts elsewhere.
Consequently, the firm’s growth outlook looks somewhat murky, while the ongoing efficiency drive is creating a challenging backdrop across the pond. I fear that keeping, let alone winning, US defence contracts could get more challenging in the years ahead.
Weighing things up, I’m not going to buy the dip in this FTSE 250 stock. I’m happy to stick with BAE Systems and Rolls-Royce for exposure to defence in my ISA portfolio.
This post was originally published on Motley Fool
