Given the uncertainty surrounding the credit crunch, investors hunting for recession-proof stocks should consider QinetiQ, with its first-rate technologies, strong order book and solid markets.
QinetiQ (QQ.), rated a BUY by UBS
QinetiQ was borne out of the Ministry of Defence's (MoD) research laboratories, and is now one of the world's leading developers of defence technologies. It sells hi-tech products, such as Tarsier (an airport runway hazard detection system), Talon (mobile robots) and Borderwatch (a people screening and detection system).
It also generates substantial recurring revenues from support contracts. It has a £4.6bn, 25-year deal with the MoD to provide testing and evaluation services, for example. The MoD still represents around half of its sales, but this is decreasing. North America now accounts for 40% of turnover and is set to reach 50% in the medium term.
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
Get 6 issues free
Sign up to Money Morning
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Don't miss the latest investment and personal finances news, market analysis, plus money-saving tips with our free twice-daily newsletter
Locked in its research vaults, QinetiQ presides over a huge trove of very clever science that has been tried and tested in the harshest of military environments. The board has set up a Ventures team with private-equity fund Coller Capital, aiming to commercialise this portfolio of expertise in other fields, such as digital communications and nano-technology. Although loss-making for now, UBS reckons this "chest of buried treasure" is worth around £145m (22p per share).
QinetiQ released upbeat first-half figures two weeks ago. Organic sales grew 8.4%, while underlying earnings per share (EPS) leapt 29.3% to 4.6p and the dividend ticked up 10.8% to 1.33p. Revenues have been driven partly by the success of its Talon robots, which have been deployed in Iraq and Afghanistan to defuse roadside bombs.
The outlook is positive, with the order book standing at a massive £5.6bn and cost savings being realised; 400 jobs are to be shed (3% of its 13,500 workforce), which will help boost operating margins from 9.2% last year to 11% in the medium term.
Chief executive Graham Love indicated that the company was looking to move for the first time into Australia where the government spends around £9.5bn a year on defence.
UBS expects 2007/2008 sales and underlying EPS of £1.3bn and 12.9p respectively, rising to £1.4bn and 14.1p in 2008/2009 putting the shares on p/e multiples of 14.3 and 13.1. What's especially appealing and perhaps overlooked by the City is that if you strip-out the losses incurred in the Ventures unit (£14m this year and £11m next), then EPS rises to around 14.4p and 15.3p making the valuation look even more compelling.
So what are the dangers? With a large chunk of the business in the US, the dollar's slide is a concern. And there are always risks dealing with government defence contracts, especially if there is a slowdown in US spending in the Middle East. Net debt of £325.5m, on top of a £26m pension deficit, also needs to be watched, but banking covenants are comfortably met.
With the CEO and chairman recently buying stock, I believe the shares rate as good value for the more prudent investor. UBS has a 12-month share price target of 220p.
Recommendation: LONG-TERM BUY at 197p
Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments
The five insurance policies you should have
Is Donald Trump putting the US dollar in danger?
