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BAE well placed in an insecure world

NATO orders could multiply
February 24, 2022

 

  • Worsening global geopolitical situation
  • Marked increase in Maritime order intake

On the day that BAE Systems (BAE) revealed an 8 per cent rise in underlying trading profits to £2.2bn, Russia unleashed its military forces on neighbouring Ukraine. It may seem slightly distasteful, but western defence contractors will be weighing up the chances of a significant step-up in military spending by NATO members.

However, the FTSE 100 constituent’s full-year figures suggest that geopolitical tensions are not confined to eastern Europe. China may well feel emboldened to take decisive action in relation to Taiwan, while further increasing its influence in the Asia Pacific region. BAE, as the largest defence provider in Australia, is set to benefit from the strategically important AUKUS announcement made in September 2021. Australia's Hunter Class Frigate programme is underway and the group’s engineering teams have been tasked with providing software and hardware upgrades to the Australian Mk 127 Hawk aircraft trainer fleet following a A$1.5bn (£796m) commitment by the Australian government.

BAE’s air segment delivered 42 per cent of group revenues, while generating a 10.3 per cent return on sales, driven by increased F-35 and Typhoon support activity, along with rising MBDA (the European multinational developer and manufacturer of missiles) volumes.

The MBDA joint venture, in which BAE holds a 37.5 per cent stake, is expanding its capabilities following the award of a £550m contract by the Ministry of Defence to develop an air-to-ground strike weapon for the UK F-35 combat aircraft. The group is also moving ahead with the Tempest next-generation Future Combat Air System programme, though the front-loaded investment requirement weighed on margins.

The maritime business witnessed a marked increase in order intake, up by 15 per cent to £4.3bn, and delivered an 8.4 per cent return on sales. Design and concept work is underway on the Royal Navy's next generation of submarines, while construction has begun on the first three City Class Type 26 frigates.

Logic dictates that the situation in Ukraine could intensify government focus on protecting key infrastructure assets. BAE’s Cyber & Intelligence business has already seen strengthening order intake in the applied intelligence space, including a Systems Engineering contract from the US Navy worth around £350m.

Finances look sound. On an IFRS basis, net operating cashflow of £2.45bn is in line with profits and the group’s share of net post-employment benefits deficit more than halved to £2.1bn. Shares are trading in line with consensus at 13 times forecast earnings, and though it’s a ‘slow burn’ stock – steady growth rather than accelerated – the worsening global geopolitical situation should underpin defence budgets. Buy.

Last IC view: Buy, 561p, 29 Jul 2021

BAE SYSTEMS (BA.)   
ORD PRICE:632pMARKET VALUE:£ 19.9bn
TOUCH:630-632p12-MONTH HIGH:640pLOW: 457p
DIVIDEND YIELD:4.0%PE RATIO:11
NET ASSET VALUE:236p*NET DEBT:49%
Year to 31 DecTurnover (£bn)Pre-tax profit (£bn)Earnings per share (p)Dividend per share (p)
201717.21.0726.021.8
201816.81.2231.322.2
201918.31.6346.423.2
202019.31.6040.723.7
202119.52.1155.225.1
% change+1+32+36+6
Ex-div:21 Apr   
Payment:01 Jun   
*Includes £11.7bn in intangible assets or 372p a share