UK Edition
Questor: BAE Systems isn’t a sinking ship but its pension scheme makes it a sell
In August last year we tipped shares in BAE Systems, the defence giant, as a buy. It has proved to be a sound suggestion, but Questor believes that the time has come to sell.
At the time of our tip the shares were trading at 446.1p and at an undemanding price to earnings ratio of 11.6. We felt that the market was undervaluing the company’s defensive qualities and the fact that its contracts with governments virtually guaranteed its long-term income streams.
We reiterated the advice in July this year when the shares stood at 534p.
Yesterday’s closing price of 597½p represents a gain of 34pc on the original tip, although the shares have dipped a little from a recent peak of 613½p last month.
While we remain happy with the company as a business, such a strong run in the shares market inevitably tilts the balance between risk and reward. To put it another way, the shares no longer seem such a bargain.
But the catalyst for our switch to a “sell” rating is a recent move by a fund manager we respect, Alex Wright of Fidelity.
Mr Wright, who runs the firm’s Special Situations fund, formerly managed by the investment legend Anthony Bolton, sold his stake in BAE Systems after his team conducted some detailed analysis of the company’s balance sheet – and in particular its pension scheme.
Mr Wright pointed out that understanding pension scheme accounts was a difficult, complex task (and incidentally one for which many fund managers and stockbrokers were ill-equipped).
He said the variables involved, such as assumptions about investment growth, meant pension deficits were “prone to large revaluations” and that a scheme’s trustees could agitate for the company to increase its pension contributions, meaning that less money would be available for investing in the business or paying dividends to shareholders.
“After looking in detail at the nature of the BAE scheme and its forthcoming review, I believe there is a possibility that the company may have to significantly increase its cash contributions, beyond the current expectations of the market,” Mr Wright told Questor.
“I believe that the balance of risk and reward in this case is unfavourable, particularly in comparison to other investment opportunities in the market.”
Our advice is to bank your gains and reinvest the proceeds in stocks whose financial position is less exposed to the dangers that a large pension scheme can pose.
Questor says: sell
Ticker: BA.
Update: Capita
By contrast with the success of our BAE tip, our suggestion on Oct 4 that investors hold on to shares in Capita, the outsourcing firm, at 666½p has not proved to be Questor’s finest hour: the price has fallen by about 32pc since then, partly because of a profits warning last week.
We based our tip on the actions of Neil Woodford, Britain’s best-known fund manager, who decided not to sell his Capita shares following an earlier profits warning in September, which caused the shares to fall by 30pc. Their current price of 452.4p compares with about £12 at the turn of the year and 952p before the first profits warning.
We followed up our “hold” tip with the reassuring news that Mr Woodford would retain his stake after meeting the company’s management. He said the meeting had convinced him that Capita would not need to cut its dividend or ask shareholders for more money.
This week it emerged that he had increased his stake in Capita, albeit only slightly. In an announcement to the Stock Exchange on Monday, Mr Woodford’s firm said its holding had risen from 66.7m shares to 68.7m, an increase of 2m. The purchase would have cost about £9.6m and took the firm’s holding to more than 10pc.
The fall in Capita’s share price this year does feel extreme and we again advise holding on to the shares.
Questor says: hold
Ticker: CPI
Questor archive: telegraph.co.uk/questor
Contact us: questor@telegraph.co.uk