QinetiQ 'largely shielded' from UK short-cycle pressures, Berenberg upgrades

Berenberg, which cut its target price to 235p from 310p, said it believes UK aerospace and defence stocks "are experiencing wide-ranging short activity, creating real opportunity".

QinetiQ now looks attractive within the sector and in a wider market context on the basis of a valuation of 12 times 2020 expected earnings, good cash flow visibility and net cash of £200m that is around 20% of its market cap.

Occupying a niche research & development space in the UK defence market with multi-year contracts on a £2bn funded backlog, QinetiQ's offerings are largely shielded from the pressures in the UK defence market that have sent investors packing from the sector, said analyst Charlotte Keyworth, suggesting it is shorter-cycle products that under the most acute near-term demand pressure.

The 3% organic growth at Qinetiq's interims was "encouraging" in an environment where peers such as Ultra Electronics, BAE Systems and Cobham are struggling to grow.

As a normally highly cash-generative business, Keyworth looks beyond peak capex of £90m next year and sees normalised levels returning in the 2020 fiscal year, where the company will generate a 7.3% free cash flow yield, "which looks appealing".

"Margin pressure is now well-understood in the EMEA Services division and it is our view that consensus estimates sufficiently reflect the continued impact," she said, forecasting a 290 basis point reduction in the 2019 year to an operating margin of 12.3%.

"The removal of £10m in operating profit essentially 'rebases' QinetiQ’s earnings, with less than £1m exposed per annum thereafter. We believe this to be a consideration currently overlooked by the market."