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UBS upbeat on European defence sector on US valuation gap; upgrades rating for QinetiQ

The UBS analysts said: “We expect defence budget growth of low- to mid-single digit in France, Germany and the other European nations, and mid- to high single digit in the US. The country where we see limited defence upside, if not cuts, is the UK“

QuinetiQ fighter
They upped QinetiQ to ‘neutral’ as they “believe that post the recent underperformance the stock now prices in the increasing downside risk to UK defence budget”

Swiss bank UBS is upbeat on the European defence sector, for which it sees 10% upside potential as the valuation gap with its US peers has hit an historical peak, having meaningful widened over the past six months, leading it to upgrade its rating for QinetiQ PLC (LON:QQ.).

In a note to clients, the UBS analysts said they remain confident that, on defence budgets, the “direction of travel has not changed in Europe where new development programmes on ‘big ticket’ items are mentioned (new generation fighter, the European Defence Fund, French deterrent replacement, combat drones).”

READ: QinetiQ marches higher as Barclays upgrades to ‘overweight’

They said: “We expect defence budget growth of low- to mid-single digit in France, Germany and the other European nations, and mid- to high single digit in the US. The country where we see limited defence upside, if not cuts, is the UK “

Despite this, the UBS analysts have upgraded their stance on FTSE 250-listed QinetiQ to ‘neutral’ from ‘sell’, as they “believe that post the recent underperformance the stock now prices in the increasing downside risk to UK defence budget.”

The analysts also raised their full year 2020-2022 underlying earnings (EBIT) numbers for QinetiQ by 1.5% on slightly improved growth in EMEA Services long term supported by increased capex spending, but trimmed their target price to 242p from 245p.

In late morning trading, QinetiQ shares were up 1.1%, or 2.7p from 242.9p.

READ: Berenberg wings shares in BAE Systems, downgrading the defence contractor's rating to ‘hold’

The UBS analysts, however, raised their target prices for two other UK defence names, with that for blue chip BAE Systems PLC (LON:BA) upped to  655p from 625p, reflecting the Qatar Eurofighter contract extension, and the target for mid cap Cobham PLC (LON:COB) hiked to 163p from 150p as a “restructuring story rather than an end-market one”.

Cobham shares added 2.3%, or 3.3p at 147.0p, but BAE shares slipped 0.1%, or  0.5p lower to 614.5p.

Quick facts: QinetiQ

Price: 336.4 GBX

LSE:QQ.
Market: LSE
Market Cap: £1.91 billion
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