Robert Stephens, CFA, discusses the appeal of two companies that have recently refreshed their growth plans.
Making fundamental changes to a company’s strategy can be painful in the short run, but may also lead to improving financial performance in the long run.
Changes currently being made at aerospace and defence company Rolls-Royce (LON:RR) look set to improve its financial outlook in what is a highly competitive industry. Likewise, housebuilder Bovis (LON:BVS) is improving its customer satisfaction and profit growth outlook through a revised strategy.
Both stocks have made impressive gains in 2019, but further growth could be ahead in the long term.
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Last week’s trading update released by Rolls-Royce showed that it is on track to meet its financial guidance for the full year. However, the headcount reductions and changes to the culture of the business which are currently being made are expected to only be fully felt over the medium term. They could make the company leaner and more productive, which may boost its competitive advantage at a time when its key markets are experiencing increasing growth rates.
For instance, defence spending over the next four years is forecast to rise at an annualised rate of 3.3% per year. Having risen by 0.7% per year over the last eight years, a step-change in growth could provide a tailwind for industry operators. Likewise, civil air traffic is forecast to grow by 4.4% per annum between now and 2037. With Rolls-Royce also expected to diversify its operations through a move into producing engines for narrowbodied aircraft during that time, its sales growth could experience two significant catalysts.
Therefore, while Rolls-Royce has a forward P/E ratio of 31, it offers long-term growth potential. Its revised strategy could transform its financial performance and help to justify its high present-day rating.
Disappointing customer satisfaction levels have proved to be Bovis’ Achilles heel in recent years. They have cost the business from both a financial and reputational perspective. Under a new CEO, however, the company has slowed down its pace of growth in order to focus on quality issues. In doing so, it has obtained a 4-star HBF (Home Builders Federation) rating.
Alongside this, Bovis’ operating margin increased by 390 basis points in 2018. It has also improved its balance sheet strength, with it continuing to have a net cash position that is providing it with confidence to increase dividends per share.
Since the housebuilding market is benefiting from low interest rates and the continued impact of the Help to Buy scheme, operating conditions for the sector have been strong in recent months. Although there are political and economic risks ahead for the UK economy, an undersupply of new homes relative to population growth could mean that Bovis is able to generate improving financial performance.
The stock has a P/E ratio of just 10. With its revised strategy yet to have its full impact, the company could offer an improving investment outlook over the long run.