BAE facing US disruption

Very few outside the inner circle had anything kind to say about BAE Systems' proposed merger with EADS. In the end, political bickering over headquarters and strategic stakes killed the deal. Inevitably, talk has moved on to a possible tie-up with a major US defence contractor, but a scheduled third-quarter trading update is a reminder that BAE has a business to run.

Nothing much has changed while management has spent the past month locking horns with fuming shareholders and heads of state. If long-running price negotiations with Saudi Arabia on the Typhoon Salam programme go well, BAE still expects modest growth in underlying earnings per share this year. At least £500m of cash is due from Salam by the year-end, too, and at least £7bn of new five-year contracts are up for grabs there. Elsewhere, a £2bn Typhoon order from Oman is almost in the bag and the UK "remains stable". Uncertainty in the US is the big worry, though. BAE warns that "some limited trading disruption" is likely in the last quarter of 2012 given the US government now operates under a Continuing Resolution. It also remains to be seen on which programmes the axe will fall.

Deutsche Bank says...

Buy. The key issue will be to rebuild investor confidence about the earnings and dividend sustainability of BAE as a standalone entity. The possible announcement of a £500m share buy-back programme before receipt of the cash owed by Saudi Arabia - expected by the year-end - would be a positive catalyst. Delivering on numbers in the second half will also be key. We still see potential transatlantic options existing in the mid term, but not this side of the US election or clarification of US sequestration in January 2013. Although the defence budget backdrop remains difficult, we see appeal in BAE's valuation and near-6 per cent yield, so retain our buy rating and 340p target price.

Investec Securities says...

Hold. Following the collapse of the EADS talks, BAE's trading update is uncontroversial and our forecasts for adjusted pre-tax profit of £1.82bn and EPS of 40.2p in 2012 should comfortably be met. The aerospace and defence group remains a solid, cash-generative business operating in a low-growth revenue environment. That partly explains the lowly rating, which we view as unlikely to change materially in the near term, at least while there is heightened uncertainty in the US market. We move to a hold rating from a sell, given the shares have fallen back to below the pre-EADS talks level, but reduce our price target from 350p to 325p.