Best defensive UK shares to buy in Q3

With the UK economy in worse shape than economists thought, it may be time for investors to batten down the hatches and look again at investing in defensive stocks.

Economists at Citigroup expect inflation to hit 18.6% in January due to spiralling wholesale gas prices. Meanwhile, the S&P/Cips global flash UK composite purchasing managers’ index, which measures private sector activity, fell to 50.9 in August from 52.1 last month. This was the lowest reading registered since February 2021, during the Covid-19 pandemic lockdown – an 18-month low.

“The UK private sector moved closer to stagnation in August, as mild growth of activity across the service sector only just offset a deepening downturn at manufacturers,” said Annabel Fiddes, economics associate director at S&P Global Market Intelligence.

With the prospect of a looming recession, high inflation and the continuing war in the Ukraine, here are what we think could be some of the best defensive stocks to invest in this month.

British American Tobacco – solid dividend payer

Shares in British American Tobacco have had a great run this year, up 29%, boosted by the flight to defensive stocks from growth stocks, such as technology shares, due to fears about the Ukraine war and inflation. However, there could still be further upside potential.

What’s more, the company is known for being a solid dividend payer, with the shares yielding over 6%, which should attract income seekers. BATs’ business throws off a lot of cash, with management now expecting operating cashflow conversion of 90% for the full-year. The company is also returning £2 billion to shareholders this year.

With a recession on the way in the UK, momentum should continue to be behind the shares. Rightly or wrongly, the nature of BATs’ business is sticky, with smokers often seeing their purchases as a necessary rather than discretionary buy.

Recent half-year results were solid, with revenues up 5.7% to £12.8 billion, boosted by growth in BATs’ vaping and ‘non-combustible’ products. Its new categories division grew sales by 45% to £1.3 billion during the period, while sales of traditional tobacco products grew by 2.3%, bolstered by strong pricing. Non-combustible products now account for 14% of revenues.

A fly in the ointment is a US Department of Justice investigation into allegations BATs breached sanctions, for which the company has made a £450 million provision. Due to the nature of BATs’ products, the shares are also unlikely to find their way into ESG (socially and environmentally responsible) investment funds anytime soon.

At 3,484p, the shares are still some way off their five-year highs of 5,018p. In July, analysts at Barclays increased their target price on the shares from 4,200p to 4,400p, while those at Morgan Stanley raised theirs from 3,780p to 4,000p.

BAE Systems boosted by geopolitical tensions

Shares in the defence contractor have had a phenomenal run this year, rising 43% to 814.6p. However, there could be further growth potential in BAE's stock. With geopolitical tensions continuing to rise, such as the Ukraine war and concerns over China’s intentions towards Taiwan, governments are increasing their defence spending.

In the first-half results reported in July, revenues rose to £10.5 billion from £10 billion the previous year, reflecting resource and supply chain issues, while underlying earnings before interest, depreciation and amortisation (EBIT) rose 4.4% to £1.1 billion.
The half-year order intake also increased by 70% from £10.6 billion to £18 billion. Meanwhile, the order backlog stands at £7.7 billion – up 17% from £6.6 billion in the same period last year.

BAE has landed a slew of contracts, including an 18-year agreement to support US intercontinental ballistic missiles, a £575 million contract to support the US Army’s Defense Super Computer Center and a further £2.5 billion of funding towards the British Navy’s Dreadnought programme. Meanwhile, production on the F-35 is at full levels.

BAE also introduced a new three-year £1.5 billion share buyback scheme at the half-year results.

In May analysts at Deutsche Bank Aktiengesellschaft raised their price target on the shares from 860p to 970p, while those at Barclays think the shares could hit 1,020p. The shares trade on a current price earnings ratio of 18.

AstraZeneca – going from strength to strength

Traditionally, healthcare is a safe port in a storm because, unfortunately, patients around the world continue to become ill whatever the state of the world economy. What’s more, pharmaceutical giants tend to command strong pricing power for their products, although, of course, right now no company is immune from inflation.

AstraZeneca shares have had a great run this year, thanks to the flight by investors to defensive stocks and the success of its Covid vaccine, and are up 33% to 11,364p. However, there could be further growth to come. Half-year results in July were impressive, with group revenues up 48% to £22.1 billion, boosted by growth in all the company’s disease areas and the acquisition of Alexion. Total revenues from oncology grew by 22%, including a milestone payment.

AstraZeneca increased its earnings guidance for the full-year at the results due to “strength in its overall business”. Total group sales are now expected to rise by a percentage in the low twenties – previously the high teens, while forecasts for core earnings per share remain unchanged in the mid to high twenties. Meanwhile, the purchase of Alexion, a company specialising in rare diseases, has boosted and diversified the pharma giant’s product portfolio.

What’s more, its new breast cancer drug Enhertu could change the way the disease is treated and could become a “multi-blockbuster,” according to analysts, who think it could be used to treat a variety of hormone-sensitive cancers. Analysts at broker Jefferies forecast it could deliver peak sales of $2.5 billion in breast cancer alone and up to $6.6 billion of peak sales in all cancer indications.

Analysts at Shore Capital recently set a price target of £120 on the shares with a ‘buy’ rating. The shares are highly rated but are worth buying for their defensive qualities and growth potential.