UK Markets closed

I’d sell this stock to buy the BAE share price today

Alan Oscroft
Plane on runway

I don’t like seeing a British engineering firm suffering, but that’s what’s been happening at Senior (LSE: SNR), whose share price is down 35% over the past five years.

A 12% drop early Thursday morning didn’t help, on the back of a trading statement that was less buoyant than at the interim stage. 

Despite 2019 performance set to be “broadly in line with our expectations,” according to chief executive David Squires, there was unexpected news that “in recognition of the challenges in some of our Flexonics and Aerospace markets, Senior is implementing a restructuring programme to drive improved returns.”

Restructuring

The restructuring is going to include job losses, cost-cutting, moving “major work packages” to cheap-labour Asian countries, and closing the firm’s South Carolina aerospace facility by early 2020. The new strategy, dubbed ‘Prune to grow’, is set to incur a restructuring charge of around £20m, with £6m in cash costs expected to show up in the 2019 books.

With this happening, and the firm already well into the disposal of non-core businesses, is it a good time to invest? I don’t think so. Despite the share price slump, we’re still looking at a P/E of around 12. That’s not high, but it’s not low enough to attract me to a company facing Senior’s difficulties.

The fact that cutting costs has become a priority also makes me cautious over the forecast 4.2% dividend yield. Although it would be twice covered, should a company facing a costs squeeze be paying out so much? Especially when it was shouldering net debt of £268m at the end of the first half?

My pick

I’d be going for BAE Systems (LSE: BA) instead, which also released a trading update Thursday.

BAE shares are up 27% over the past five years, but as the price has retrenched a little from a peak in July 2018, we’re looking at P/E multiples of around 12 to 13. That’s close to Senior’s valuation, but without the apparent need to prune to grow. The past six months of the current year have seen BAE shares starting to pick up again, forecasts are strengthening, and the company now says it expects underlying EPS to “grow by mid-single-digit percent.”

There’s a dividend yield of 4% on the cards, and we’re seeing the annual payment comfortably keeping up with inflation. If current forecasts come good we’ll have seen 12.5% dividend growth over five years, and that adds up to a very satisfactory overall return.

Dividend safe

BAE says it “continues to target in excess of £3bn of free cash flow over the three-year period 2019-2021, and expects 2019 net debt to be broadly unchanged from the net debt at 31 December 2018.”

At that stage, the debt figure stood at £904m, which looks like a very significant sum on the face of it. But it’s less than half the firm’s 2018 underlying EBITDA, which is a very respectable comparative. Coupled with such strong cash generation, I really don’t see any pressure on the dividend.

BAE’s dividend policy is one of “long-term sustainable cover of around two times underlying earnings and to make accelerated returns of capital to shareholders when the balance sheet allows.” I see that as both conservative and attractive, and BAE is a buy for me.

More reading

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