BAE Systems sees orders build as security threats multiply

A quick review of analyst reaction suggests that half-year numbers from BAE Systems (BA.) are likely to generate upwards earnings revisions. The UK defence heavyweight registered significant sales growth across its various segments, along with an increased backlog of orders.

The group delivered sales growth of 11 per cent on a constant currency basis, while order intake, at £21.1bn, was up 16 per cent, leading to a record order backlog of £66.2bn. Underlying trading profits were 10 per cent to the good at £1.3bn, while free cash flow generation tipped over the £1bn mark and was ahead of analysts’ expectations, partly due to UK government pre-payments on the Maritime segment’s Dreadnought class submarine programme.

Management highlighted positive developments within the Platforms & Services segment, with increased activity in the Hägglunds and Ship Repair businesses. The Air sector also continues to benefit from the multi-channel development of the Tempest sixth-generation fighter aircraft. Prospects at the Cyber & Intelligence unit are more positive than ever as the conflict in Ukraine has further demonstrated the security challenges posed by the expansion of asymmetrical warfare. It’s a growth area within the group as it responds to the “evolving global threat environment”, so investors needn’t worry over margin contraction in the period under review given that additional investments have been made relating to space and multi-domain networking.

The group’s prospects are intertwined with geopolitical events across the globe. Management notes that the global reach, scale, and longevity of BAE's business provides significant opportunities in response to recent multinational endeavours such as the trilateral AUKUS agreement designed to bolster defence capabilities in the Asia Pacific region and the Global Combat Air Programme for the Tempest fighter jet. Finland’s recent entry into the NATO fold comes as previously reluctant member states within the alliance finally seem prepared to meet their spending obligations under the treaty.

The group’s balance sheet remains in decent order despite the capital-intensive nature of the business. BAE exited the first half with a cash position of £3.2bn, while net debt (excluding lease liabilities) has fallen by 42 per cent since the 2022 half-year to £1.83bn. A higher interest rate environment has translated into a net pension position in an accounting surplus.

UBS gives diluted EPS of 58.06p for the full year, rising to 63.92p in 2024.

Sales growth has been achieved under what BAE’s finance director, Brad Greve, describes as “a disciplined capital allocation policy”. The shares are hardly in bargain basement territory at 17 times forecast earnings, but given BAE’s capital returns and new-phase cycles in global defence spending, we reiterate our buy call. Buy.

Last IC View: Buy, 888p, 23 Feb 2023