Investment Column: Persimmon's prospects are looking cloudy

Meggitt; Ultra Electronics

Our view: Sell

Share price: 370.2p (+21.7p)

The last time we looked at Persimmon, it was on the back of a rather positive trading update. Despite this, we chose to be cautious and issued a "hold" recommendation rather than urging "buy". We took that stance because of what, at the time, was an uncertain outlook for the housing market.

Months later, the market's prospects have, if anything, become only darker as the coalition Government takes the axe to spending in the middle of what remains a very sluggish recovery.

On the upside, Persimmon is a company that continues to perform well. Yesterday's trading statement showed evidence of higher sales and improving debt levels and margins.

If we had to back a horse in this field, Persimmon would have to be a leading candidate. Moreover, the long-term fundamentals are promising both for Persimmon and the wider property sector and valuations are anything but stretched.

All the same, with recent house price surveys showing a moderation in the pace of growth, we fear that short-term sentiment towards the housebuilders will remain lukewarm at best. We are happy to admit that this is not the most fashionable of views. Many City analysts are recommending that investors pile in because this stock and its peers look decidedly undervalued. Viewed in isolation, the numbers are undemanding, with Persimmon's shares currently trading at a significant discount to forecast net asset values (NAV).

Panmure Gordon, for instance, pegs the NAV at 555p, whereas the shares sit at well below the 400p mark. Although clearly supportive of the long-term investment case, we would argue that, in the near term, these numbers could very easily be overshadowed by fears of a pullback in the housing market. It is also worth noting that positive-looking fundamentals have not stopped the share price from easing back by about 20 per cent since the beginning of the year, so sell.

Meggitt

Our view: Sell

Share price: 308p (+6.2p)

It is a long time since this column last looked at Meggitt, a defence company that largely supplies the aerospace industry. In fact, it was in September 2006, when the shares stood at 317.75p, that we said "hold".

After oscillating a bit, the stock went into a sharp reverse caused by the downturn, followed by an equally sharp recovery. Last month, for the first time in ages, the share price approached that level again (albeit briefly). Where it will go from here depends on your view of the economy and the prospects for the aerospace industry generally. We are sceptical. Government deficits in Europe will constrain spending on this side of the Atlantic, and deficits will also constrain spending on the bloated US military budget too, particularly when it comes to big-ticket flying toys.

Meggitt has a civilian side to its business and can therefore look elsewhere for sales, but we remain sceptical about the prospects for the aerospace market generally. Meggitt is not expensive, compared to some of its peers. Citi has it on 11 times this year's forecast earnings, with a moderate prospective yield of 3 per cent, and it calculates a 30 per cent upside.

We are not convinced. In fact, if we held any of the shares, we would be inclined to pull out, not least because after a strong rally in the first part of 2010 we do not see that much scope for further upside. Sell.

Ultra Electronics

Our view: Hold

Share price: 1556p (+28p)

Ultra Electronics, formerly a defence electronics company focused on the UK, has expanded so much that more than half of its sales were in North America last year. It has also diversified and now makes technology used on battlefields, in civil and military aircraft, in defence and security systems and in the transport and energy sectors.

Yesterday, the company sealed its biggest-ever contract – a seven-year, $650m deal with the US Department of Defence for Ultra's "Battlespace" IT system. This will provide the US Army with high-capacity, line-of-sight radios for forces engaged in land operations. While the share price did not take off – the contract was priced after it was flagged at the end of the year – Ultra is bullish that the new deal will translate into further contract wins.

Ultra's strength is in its diversity. No one platform accounts for more than 4 per cent of its sales, which will insulate it against the worst should defence spending dry up. Investec has it on 13.2 times estimated 2011 earnings, against an average of 10.2 times in the aerospace and defence sector, but it is probably worth a premium. The latest contract and potential for expansion suggests these shares are worth holding.