Even after improving sales by 22% and earnings by 12% last year, shares of automotive and aerospace engineer GKN (LSE: GKN) trade today at a very sedate 9.6 times forward earnings, well below their historic average over the past five years. But is this a bargain basement valuation investors should leap at?
Well, the main reason shares of the FTSE 100 giant are so cheap is that investors are growing increasingly wary of the outlook for automotive markets around the world. In its Q1 trading update, the firm guided for global production growth of just 2% for all of 2017 as sluggish economies in the US and Europe dented demand growth.
Thankfully the company isn’t solely reliant on the automotive market due to its massive aerospace division. Looking ahead, the outlook for this market is much more positive as militaries in the developed world return to budget growth and global aircraft orders march higher and higher, thanks to increasing consumer demand for air travel, cheap debt and a benign economic environment.
Furthermore, GKN has proven over the years its ability to grow appreciably ahead of overall market growth thanks to its deep connections with customers, highly skilled workforce and global reach. Indeed, in Q1 sales of the company’s automotive drivetrains bumped up 6% year-on-year (y/y) despite product category growth of just 2%. Likewise, the firm’s £500m purchase of aerospace engineer Fokker in 2015 shows that the company can always use its huge heft and financial firepower to grow through acquisitions when necessary.
While the company’s large pension deficit is something to keep an eye on, GKN should continue to perform very well as long as the global economy continues to grow. Together with considerable potential to shift margins upwards and a great valuation, now could be a good moment to take a closer look at this cheap growth stock.
Small name, big ambitions
Another FTSE 100 growth star trading at a reasonable valuation is software provider Micro Focus (LSE: MCRO), whose shares trade at 15.3 times forward earnings. This is cheaper than the company’s shares have been since early 2015 and comes even as it has boosted earnings by 60% over the past four years.
The reason the company’s valuation has fallen back of late is that investors have grown skeptical over the $9bn purchase of HP Enterprise’s software business that is due to go forward this September. This is certainly a large deal for the company and isn’t without risk as it will lead to pro-forma net debt rising to 3.3 times EBITDA.
That said, management has built the entire business around acquiring mature software systems, cutting costs and improving cash flow. This is something they’ve done very well in the past. And with high levels of recurring revenue and plenty of cash flow due to EBITDA margins of 43.9% last year, I wouldn’t discount management’s ability to repeat past success.
With an attractive valuation, solid and growing 3.1% dividend yield and great growth prospects, now may be the best time in a long while for tech-hungry investors to consider Micro Focus.
But if Micro Focus is still too expensive for you, I recommend reading the Motley Fool’s free report on its Top Small Cap of 2017 that trades at just eight times earnings. This value investor’s dream offers enviable growth prospects as well as it has increased earnings by double-digits for four straight years.
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Ian Pierce has no position in any shares mentioned. The Motley Fool UK owns shares of GKN. The Motley Fool UK has recommended Micro Focus. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.