The heavily leaked strategic defence and security review signalled a real shift in the UK's strategic priorities over the next 20 years. The implications for the country's listed defence companies has opened up a clear split between those which have scale and a range of end-markets - and those which don't.
WINNERS:
BAE has come off better than most people expected. The company can thank a competent legal team, and equally incompetent Ministry of Defence (MoD), for inserting clauses into the carrier contract that would have made cancellation more expensive that continuing with the project. The company's shares are up 25 per cent in the past two months. The news that £500m extra will be pumped into cyber warfare is set to enhance the returns from BAE's £500m purchase of information systems consultancy Detica, and perhaps revive the old BAE/Logica tie-up talk that the market knows and loves. Logica shares, incidentally, are up nearly 30 per cent since July.
Babcock also comes up smelling of roses. Not only does the defence contractor get to support the building of the two aircraftless aircraft carriers, but it is increasingly clear that its takeover of VT Group has already paid dividends. Snapping up VT before it could complete its move for Mouchel looks like a masterstroke. Since then, Mouchel has run into trouble owing to its exposure to highways, and the collapse of Connaught has triggered a downward rerating of support services groups generally. Babcock also gets a boost from a renewed commitment to a Trident replacement, although the government has postponed making a final decision for a further five years. On a forward PE ratio of just 9.5 that’s below Capita and Serco, and with the VT acquisition looking to enhance earnings, it’s still one of our top buys.
LOSERS:
The biggest corporate loser by any yardstick is QinetiQ as 44 per cent of its sales are exposed to UK defence spending. The defence research and facilities management group was hit hard by the cancellation of the defence training and research project to centralise all technical training at a large facility in St Athan, Wales. Shares in the company dived by 10 per cent at one stage to less than half of the original 200p float price in 2006. Bid costs of £37m related to the project, which the company had capitalised on its balance sheet, will now be charged to profits as a non-cash item. Although St Athan was a specific contractual issue, the £14bn cost of the project, and QinetiQ's single biggest revenue opportunity in its managed services division, was simply too much to justify when budgets are so tight.
News of a £38bn procurement 'black hole' has reinforced the reputation of the MoD as a sclerotic and poorly-run organisation. That's unlikely to surprise military observers; the National Audit Office's annual review of defence projects has shown consistent over-spending for the past decade. Such long-term bungling is likely to cost around 25,000 jobs at the department.
Military nostalgists will be dismayed by the demise of the Ark Royal. There's been an Ark Royal in the fleet since the reign of Henry VIII, but the current vessel, launched in 1981, will be scrapped immediately instead of in 2014, along with the Harrier jump-jet (first flight: 1960) and the Nimrod reconnaisance aircraft (first flight: 1967). Also, about 40 per cent of the armoured corp looks set for the chop as army doctrine moves away from tank-on-tank warfare in Northern Germany.
