BAE Systems and Rolls-Royce shares have decoupled: better buy?

Rolls-Royce (LON: RR) and BAE Systems (LON: BA) shares have done well this year, helped by the strong performance of industrial companies. BAE stock is up by 16% in 2024 while Rolls-Royce has soared by over 52%. Their market caps are almost similar at £38 billion.

The same trend has happened in the past 12 months as RR jumped by 200% while BAE Systems jumped by 40%. In contrast, the FTSE 100 index, which tracks the top blue-chip companies in the UK, has risen by 11% in this period. 

Rolls-Royce vs BAE Systems stocks

Strong tailwinds

BAE Systems and Rolls-Royce Holdings are the biggest industrial companies in the UK. BAE is a major defense company that manufactures equipment like aircraft, tanks, ground antennas, and laser and LIDAR instruments. It generates most of its revenue from the United States, UK, and Saudi Arabia.

Rolls-Royce Holdings, on the other hand, is a specialist in three industries: civil aviation, power, and defense. In civil aviation, the company builds quality aircraft engines, sells them to airlines, and then generates revenue in long-term service contracts. 

In defense, the company makes products for military aircraft, land solutions, and marine products like submarines. In power, the firm makes nuclear plant and engines for ships and yachts. 

These companies are doing well as their industries face numerous tailwinds. In defense, the two companies are benefiting from the ongoing geopolitical tensions in Europe and the Middle East. Most Western countries are now boosting their defense spending and the trend is accelerating.

Rolls-Royce is also benefiting from the ongoing recovery of the civil aviation industry as most airlines have moved back to their pre-pandemic levels. In a recent note, IATA said that airline profits will jump to a record high this year.

Additionally, investors have embraced industrial companies this year. As I have noted before, companies like Emerson Electric, GE Aviation, and Illinois Tool Works have done well this year.

Valuation metrics have diverged

A closer look at Rolls-Royce and BAE Systems show that their valuation metrics have diverged recently. Data by SeekingAlpha shows that Rolls-Royce has a forward PE multiple of 30.26 and a forward PEG ratio of 1.03. 

While these numbers mean that it is an overvalued company, one can justify it by looking at its earnings growth. Rolls-Royce Holdings has a revenue growth of 21, a forward metric of 15 and a forward EBITDA growth of 30%.

In contrast, BAE Systems has a PE ratio of 21 and a PEG ratio of 1.09. It is growing at a slower pace than Rolls-Royce as its revenue growth stood at 8.56% and its forward EBITDA growth is 10.6.

In the most recent results, BAE Systems said that its revenue stood at £23 billion in 2023, a 9% growth from the previous year. Its operating profit was £2.5 billion while its backlog grew from £48.9 billion in 2022 to over £58 billion in 2023. 

Rolls-Royce, on the other hand, said that its revenue rose by 21% to £15 billion while its operating profit stood at over £1.5 billion.

Better buy: Rolls-Royce vs BAE Systems

A case to invest in both Rolls-Royce and BAE Systems can be made since the two companies are dominant players in their respective industries. 

BAE is a cheaper company in terms of valuation compared to Rolls-Royce but it is growing at a slower pace. BAE also pays a dividend with a 2.37% yield while Rolls-Royce is not paying a dividend as yet. It will likely resume its payouts if the strong revenue trend continues.

Rolls-Royce also has strong bullish momentum and numerous catalysts like the ambitious targets by the management. 

Therefore, I believe that Rolls-Royce is a better investment for now although the case for BAE Systems is strong.

The post BAE Systems and Rolls-Royce shares have decoupled: better buy? appeared first on Invezz