Best defensive shares to buy in Q3

With Ukraine beginning its counteroffensive and the Bank of England continuing to battle with inflation, investors face a difficult and uncertain playing field. UK interest rates continue to rise and the Bank has come under fierce criticism for failing to tackle inflation. In fact, it has launched its own review into its apparent failings to forecast the persistence and strength of the inflationary environment.

Meanwhile, the UK economy avoided recession once again, albeit growing by just 0.2% in April, according to the Office of National Statistics (ONS). However, real earnings continue to fall, while the food price inflation continues to be stubborn, despite wider inflation falling, according to ONS figures.

Bearing all these wider macro-economic issues in mind, what could be the best defensive stocks to consider right now?

BAE Systems – well-positioned in an uncertain world

With the world facing various military perils, including Russian aggression in Europe and Chinese expansion in the South China Sea, investing in defence stocks seems a sensible option. BAE shares had a stellar run last year following the invasion of the Ukraine as worldwide concerns about security spiked.

The defence contractor has contracts in place with the Ministry of Defence, the British Navy, the US and, more controversially, Qatar, which recently received a batch of Eurofighter Typhoons from the company. BAE is also likely to benefit from the new AUKUS military tie-up between US, the UK and Australia. The company is also currently testing its new supersonic stealth plane known as the Tempest, as well as working on the UK Navy Dreadnought programme and producing Hunter Class frigates for the Australian Navy.

In February, BAE revealed new orders worth £37 billion for last year, boosting the order backlog to £58.9 billion. This is mainly from existing contracts, according to the company’s management. Revenue growth for the full-year 2022 was unexciting at 4% to £21.3 billion, while operating profits were flat at £2.4 billion. However, capital expenditure is currently high and it typically takes around 18 months for new orders to hit the bottom line.

At the full-year results, financial director Brad Greve said that the company expects EPS (earnings per share) growth, top-line growth and continued margin expansion in 2023. BAE recently held a capital markets day, which should boost its profile among City analysts. What’s more, it also has a three-year share buyback programme worth £1.5 billion. The company also raised the full-year dividend by 7.6%. Meanwhile, the Paris Air Show this month – the world’s biggest aerospace and defence event – could also help boost sales.

The shares are up 27% this year to 968p, but are not expensively rated compared to their peers and continue to be worth buying. Analysts at broker Citigroup think the shares could reach 1,146p.

Microsoft – steady as she goes

At $342.3, shares in Microsoft are already up 40% this year. Shares are benefiting from the current hype in artificial intelligence, having launched its ChatGPT product earlier this year, as well as strong third-quarter results.

Revenues for the quarter ended 31 March rose 7% to $52.9 billion (10% at constant currency rates), while operating income rose 10% (15% at constant currency rates) to $22.4 billion. Meanwhile, net income came in at $18.3 billion – up 9% (14% at constant currency rates). The results were boosted by strong sales of productivity and cloud computing software.

“The world's most advanced AI models are coming together with the world's most universal user interface - natural language - to create a new era of computing,” Satya Nadella, chairman and chief executive officer of Microsoft, told investors. “Across the Microsoft Cloud, we are the platform of choice to help customers get the most value out of their digital spend and innovate for this next generation of AI.”

What’s more, some City experts think the more well-established technology companies offer the same defensive qualities that utility companies used to, with solid, reliable income.

However, it’s not all plane sailing. Microsoft is facing a regulatory backlash over its purchase of gaming firm Activision Blizzard in the UK and US after a US judge temporarily blocked the move.

Nevertheless, analysts at brokers Evercore ISI currently have a price target of $400 on the shares, while those at Credit Suisse think the shares could reach $420.

Diageo – showing resilience

After a previous strong performance last year, the beverage giant shares have fallen back and are down 2% for the full-year to 3,354p. In shock news, the company lost its long-time chief executive Ivan Menezes recently, who died following emergency surgery.

He served in the post for 10 years and was credited with overseeing the merger between Guinness and Grand Metropolitan, which formed Diageo in 1997, as well as overhauling its portfolio. New CEO Debra Crew has now taken the reins earlier than expected.

Nevertheless, despite these issues, Diageo is a solid company with an impressive portfolio of drinks brands, including Johnny Walker, Tanqueray gin and Smirnoff vodka.

The company is demonstrating resilience in the current inflationary environment, with half-year revenues up 18.4% to £9.4 billion, boosted by strong organic net sales growth of 9.4%, as well as a positive dollar impact. Meanwhile, operating profits rose 15.2% to £3.2 billion. Diageo is benefiting from its scale and the move toward premiumisation – the popularisation of premium brands.

The shares are trading near their 52-week lows and are worth buying. While analysts at brokers Barclays recently cut their price target on the shares, they still think they could reach 4720p.

Past share price performance is not a guide to future performance.