Head To Head: Rolls-Royce vs BAE Systems

Published in Company Comment on 12 October 2012

Which aerospace and defence giant should you buy today?

In this series, some of your favourite FTSE 100 (UKX) shares go head to head in a three-round contest for superiority.

In Round 1, the firms fight on earnings; in Round 2, on dividends; and Round 3 is a battle of the balance sheets. The winner will be the company that has racked up most points at the end of the contest.

Stepping into the ring today are aerospace and defence giants Rolls-Royce (LSE: RR) and BAE Systems (LSE: BA).

Shares in Britain's premier aerospace and defence companies have been in demand with investors over the past six months. The FTSE 100 is up 3% over the period, but Rolls-Royce's shares have climbed 10% and BAE's 12%.

Let's take our seats at ringside.

Round 1: earnings

 Rolls-RoyceBAE Systems
Recent share price885p329p
Last year price-to-earnings (P/E) ratio18.27.2
Current year forecast P/E15.78.1
Four-year earnings per share (eps) compound annual growth rate (CAGR) (%)911
Current year forecast eps growth (%)16-11
Operating margin (%)108

Sources: Digital Look, Morningstar, company reports. Winners in bold.

BAE makes a strong start to round one, scoring thumping points on P/E and narrowly taking the point for historic earnings growth. Despite Rolls-Royce hitting back hard on forecast growth and scoring a narrow-margin point for operating margin, BAE takes the round by three points to two.

Round 2: dividends

 Rolls-RoyceBAE Systems
Last year dividend yield (%)2.05.7
Current year forecast dividend yield (%)2.25.9
Four-year dividend CAGR (%)810
Current year forecast dividend growth (%)124
Forecast dividend cover2.92.1

Sources: Digital Look, Morningstar, company reports. Winners in bold.

It's a similar story in round two. BAE scores heavy-hitting points on yield and narrowly takes the point for historic dividend growth. Rolls-Royce hits back on forecast growth and superior dividend cover, but again BAE takes the round by three points to two.

Round 3: balance sheet

 Rolls-RoyceBAE Systems
Price-to-book (P/B) ratio3.72.5
Net gearing (%)-225

Sources: Digital Look, Morningstar, company reports. Winners in bold.

It's all square in the final round. BAE takes the point for P/B, while Rolls-Royce scores on gearing. BAE's gearing is certainly far from extravagant, but the negative number for Rolls-Royce indicates net cash on its balance sheet.

At the end of the contest, the companies have drawn one round and BAE has won two. The overall points tally is BAE seven and Rolls-Royce five.

Post-match assessment

This was quite a close contest, but it's worth noting that BAE took all five valuation-ratio points: historic and forecast P/E, historic and forecast dividend yield, and P/B. This suggests that BAE might just be better value than Rolls-Royce at the present time.

BAE's ratings are not only very 'cheap' relative to Rolls-Royce's, but they are also cheap in absolute terms: a P/E in single figures and a dividend yield pushing 6%, with only the P/B above the level value investors might wish for.

BAE certainly has its attractions, which are increased in my view by the recent abandonment of its likely value-destroying, and almost certainly dividend-destroying, merger with pan-European group EADS.

As for Rolls-Royce, while its business fundamentals are undoubtedly strong, any case for its shares being good value at their current level is not revealed by the set of valuation measures used in this head-to-head contest.

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> G A Chester does not own shares in any of the companies mentioned in this article.

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LordLawns 12 Oct 2012 , 12:02pm

What about their pension liabilities?

lameuse 12 Oct 2012 , 1:47pm

Many thanks for this interesting head-to-head. It is good to read your view that BAE are better off without the recent attempted merger.

jackdaww 12 Oct 2012 , 5:23pm

i believe bae pension fund is about twice the size the its market cap. and its pension deficit about 40%.
i have avoided.

equitybore 13 Oct 2012 , 7:26am

Single customer (North Atlantic alliance)+ long term declining market (military budgets are bound to be cut) = BAE
Range of customers+continuing market expansion = RR

Contest? Don't think so

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