Deutsche Bank cuts targets on UK aerospace&defence names on pound strength

The analysts bumped up their forecast for the cable exchange rate from 1.25 to 1.30, resulting in 3% 2020 EPS downgrades for Rolls Royce, Meggitt and Ultra Electronics - the worst affected of the lot.

In turn, that saw the broker's target on Rolls Royce fall from 540p to 525p, that on Meggitt lowered from 470p to 456p and that for Ultra cut from 2,100p to 2.050p.

Its targets for BAE Systems was also marked down, from 665p to 645p although that for Cobham was raised from 110p to 113p.

However, Deutsche Bank pointed out that their foreign exchange strategists were still expecting both euro and sterling to fall against the dollar out to the end of 2018, meaning that FX could turn into a tailwind for commercial aerospace names over the next 12 months.

Deutsche projected euro/dollar would drop to 1.02 by the end of 2017 and 0.95 by year-end 2018.

Meanwhile, cable was seen at 1.20 and 1.15 over those same time frames, respectively.

On a pound-US dollar rate of 1.15, Roll's 2020 IFRS15 EPS might receive a 16% boost, Ultra's 11% and BAE Systems's and Cobham's 8%, the broker said.

Within civil aerospace, Deutsche said its top picks remained, Airbus and Dassault Aviation because of their long-term margin expansion, free cash flow growth potential and attractive valuations.

In Defence on the other hand, Thales, BAE and Leonardo "hold appeal".

Regarding Rolls Royce, Deutsche Bank said: "We continue to see downside to Rolls-Royce shares and believe that management’s targeted £1bn of FCF by 2020 is more than fully priced into today’s share price. The recent FX move is also unhelpful for Rolls."