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2 defensive stocks I’d buy to beat Brexit today

Alan Oscroft
Hand drawing a red line between the UK and the rest of EU, Brexit concept.

Yes, I know, it’s a terrible pun, but I really do think the Aerospace and Defence sector is defensive in more ways than one, and I reckon it’s a great sector to be in for the long term to beat our likely post-Brexit economic weakness.

I’m not the only one who thinks so, as you’ll see if you take a look at the QinetiQ Group (LSE: QQ) share price chart. QinetiQ shares have climbed 58% over the past two years, and others in the same sector have been gaining too, even if not to the same extent.

The QinetiQ price gained an extra 6% Thursday morning on the back of interim results, as the six months to 30 September brought in a 16% jump in operating profit over the same period a year ago, to £59.7m. Underlying earnings per share picked up 14%, and the interim dividend was kept level at 2.2p per share.

Cash

The firm’s total funded order backlog has soared to £3.1bn, with £411m in orders added in the period. And on the cash front, net operational cash flow rose by 50% to £77m, with net cash at 30 September standing at £173.5m — down from £220.8m a year previously, but still strong.

Forecasts put the shares on a P/E of 16.5, though that’s based on a predicted modest drop in full-year EPS, and I think that will need to be upgraded now. Dividend yields are modest at around 2.2%, but they’re progressive and that’s what really matters.

Does this look, in Warren Buffett’s words, like a great company at a fair price? I think so, a very fair price indeed considering QinetiQ’s excellent cash flow characteristics. It’s in the top 10 on my potential buy list.

Higher valuation

Shares in Meggitt (LSE: MGGT) haven’t done quite as well as QinetiQ’s, but we’re still looking at a 30% gain over two years, and the stock is valued on a P/E multiple of 17.7 this year, dropping to 16 on 2020 forecasts. That’s a slightly higher valuation than QinetiQ, but dividend yields are a bit better too at around 2.8% while still being attractively progressive.

At the interim stage, Meggitt reported a more modest gain in underlying operating profit at 6%, with underlying earnings per share up by the same percentage. In this case we saw a 5% boost to the first-half dividend, which is in line with full-year expectations.

Free cash flow was up by an impressive 80%, but the first major difference between the two companies is cash — Meggitt was carrying net borrowings of a little over £1bn at 30 June.

Latest trading

The firm’s Q3 update a couple of days ago looked reasonably positive, and apart from some fallout from the Boeing 737 MAX problems, trading was better than expected. Margins are being squeezed a little, though organic revenue outlook has been lifted a fraction from the 4%-6% range to 6%-7%.

With forecasts for EPs growth of 7% this year and 11% next, after a few years of ups and downs (which is common in this industry with its years-long contracts and periodic payments), I think Meggitt looks like a decent long-term investment.

But for me it’s not up with QinetiQ, which remains my pick of the sector.

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Alan Oscroft has no position in any of the shares mentioned. The Motley Fool UK has recommended Meggitt. 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.

Motley Fool UK 2019