Disappointment about BAE Systems' (BA.) failure to win a £6bn UAE order and a painfully drawn-out pricing negotiation over ongoing Saudi work have contributed to the market overlooking the significance of positive developments in the US and significant recent contract wins. This leaves the shares' rock-bottom rating looking out of step with events and a forecast yield of nearly 5 per cent means investors should be well rewarded while waiting for the rest of the market to wake up to the value on offer. The share price should also continue to be supported by an ongoing £1bn share buy-back programme.
- US spending cuts watered down
- Winning more commercial work
- Big dividend yield
- Discount to sector unjustified
- Pricing on Saudi contract delayed
- Missed out on big Typhoon deals
It was an obvious boon for BAE when at the end of last year the US Congress agreed a budget deal that helped lift the fog surrounding US defence spending somewhat. Admittedly, the deal thrashed out doesn't increase the military budget, but it does reduce planned cuts by $31.5bn (£19.3bn) over the next two years - valuable time to diversify further into civilian markets. It's also likely the Pentagon's latest Quadrennial Defense Review, due next month, will shed further light on which programmes will stay and which will go.
Clarity is crucial for BAE. In 2012, the US generated 39 per cent of group sales and a significant slug of total profits. Jerry DeMuro, the new head of BAE's semi-autonomous US division, must at least manage an inevitable downturn in business there. For growth, BAE must look to the UK and overseas. Britain chipped in a third of sales in 2012, and profits are trending higher. Crucially, non-UK and US-funded new orders have risen fast, too. They doubled in 2012 to £11.2bn, and a further £5bn had been booked in the first nine months of last year.
And attention here remains firmly on Saudi Arabia, where negotiations over price adjustments to BAE's lucrative Salam Eurofighter Typhoon contract have slipped into a third year. Saudi agreed to buy 72 of the fighter jets in 2007, but is haggling over the contract's inbuilt inflation escalator and expensive modifications to the planes. BAE is still delivering the jets, but has not booked profits on the 34 already in Saudi hands. That means that unless a deal is signed soon, 3p of EPS already deferred from 2012 to 2013, and another 3p-4p of last year's earnings, will not feature in 2013 results due on 20 February, and will slip into 2014.
That is clearly unsatisfactory, and the share price has suffered as a result. But we believe the contract will be signed soon, possibly in time to make it into the 2013 numbers, according to broker UBS. And concerns that the Saudis have fallen out with BAE look wide of the mark. Relations remain "excellent", the company said last month. Contracts for guided missiles and Tornado-maintenance work worth £1.5bn were wrapped up in December, and earlier this year Saudi agreed to pay BAE £1.8bn for Typhoon support and £300m for air base construction work. There will be more.
BAE SYSTEMS (BA.) | ||||
|---|---|---|---|---|
| ORD PRICE: | 440p | MARKET VALUE: | £14.1bn | |
| TOUCH: | 439-440p | 12-MONTH HIGH: | 471p | LOW: 325p |
| FORWARD DIVIDEND YIELD: | 4.7% | FORWARD PE RATIO: | 10 | |
| NET ASSET VALUE: | 130p* | NET DEBT: | 28% | |
| *Includes intangible assets of £11.2bn, or 350p a share | ||||
| Year to 31 Dec | Turnover (£bn) | Pre-tax profit (£bn)** | Earnings per share (p)** | Dividend per share (p) |
|---|---|---|---|---|
| 2011 | 19.2 | 1.80 | 45.4 | 18.8 |
| 2012 | 17.8 | 1.65 | 37.6 | 19.5 |
| 2013** | 19.0 | 1.86 | 43.3 | 20.1 |
| 2014** | 18.9 | 1.78 | 42.8 | 20.5 |
| 2015** | 18.9 | 1.79 | 43.6 | 20.8 |
| % change | - | +1 | +2 | +1 |
Normal market size: 5,000 Matched bargain trading Beta: 0.8 **Investec Securities estimates, adjusted PTP and EPS figures | ||||
Failing to sell 60 Typhoons worth £6bn to the UAE last month pressured BAE shares, too. It has missed out on a 126 jet deal with India as well. But while the UAE deal is dead, there's an outside chance BAE could still steal the Indian contract - India is proving troublesome for winning bidder Rafale and still hasn't signed. From Denmark to Japan, big orders could come from many quarters this year. And in a major coup before Christmas, South Korea handed BAE a $1bn contract to upgrade its fleet of F-16s. On the commercial side, where BAE needs to bulk up before US spending cuts pick up in 2016, a maintenance deal with Japan Airlines was signed in October and the soon to be rebranded cyber arm is helping tackle insurance crime in Canada.
