BAE Systems reports record-breaking year

BAE Systems (LSE:BA.) is basking in the increasing heat of geopolitical tensions with a set of results which have comfortably blown past estimates. 

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The group upped its guidance at the halfway stage, reiterated the numbers at its third-quarter update and has now delivered for the full year – and then some. Revenues and the order book both reached record levels, reflecting the unfortunate sign of the times that defence stocks are squarely back in fashion, as governments around the world look to protect their interests and land from growing tensions. For shareholders, however, this has resulted in significant rewards.

For the year, orders of £36.8 billion represented an increase of 9%, swelled by orders from Turkey worth £4.6 billion for 20 new Typhoon fighter jets, $3.3 billion (£2.4 billion) worth of electronic systems and $1.7 billion for US combat vehicles. This also takes the order backlog to a record £83.6 billion, and up by 7% on the corresponding period. The nature of these orders, usually agreed over a multi-year timeframe, also leads to increased earnings visibility for an extended period, which is of comfort to longer-term investors let alone the prospects for the business. 

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Record revenues of £30.66 billion represented an increase of 10% year-on-year and was at the upper end of guidance, while a 12% rise in underlying earnings to £3.32 billion was above both market estimates and the group’s own guided growth of a 9% to 11% range. 

Free cash flow decreased by 14% to £2.16 billion given increased investment, but over a three year period came in at more than £7 billion, higher than the previously estimated £6 billion. At the same time, the prodigious cash flow also enabled net debt to be reduced by 22% to £3.84 billion, while a dividend rise took the projected yield to 1.8% which, though pedestrian, maintained a payment which has been increased for more than 20 consecutive years.

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BAE Systems remains well placed given the diversity of its operations by both business lines (“multi-domain capabilities”) and geography. Its Electronics System unit, which includes Space and Mission systems and was boosted by the previous £4.4 billion purchase of Ball Aerospace, accounts for 25% of revenues. Aircraft products are responsible for 30% of sales, Maritime Equipment 22% and Platforms & Services, which includes vehicles and ammunition 16%, while by geography the US and UK account for 46% and 28% respectively.

Headwinds may be few and far between but for investors, they need to be considered. The lack of a share buyback announcement could result in some minor disappointment even though the rationale is sound as the group diverts resources elsewhere for investment and debt reduction purposes. 

The meteoric share price rise has left the valuation well above the recent multi-year averages, suggesting that the shares are not obviously cheap, while with punchier valuations come higher expectations and more pressure to keep growing earnings to stay in line. Supply chain issues and production delays can also be a cost of doing business, while some may be deterred from investing in the sector on ethical grounds.

Even so, for the medium term at least, the future looks bright for BAE. Guidance for the upcoming year is that revenues will rise in a range of between 7% and 9%, with underlying earnings growth is expected to fall between 9% and 11%, both of which would maintain the momentum. 

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Equally, the geopolitical backdrop is a reminder that brittle relationships are seemingly never far away, ranging from potential and actual conflicts in the likes of Venezuela, between China and Japan and Russia and Ukraine. The backdrop has led to a number of governments pledging a higher percentage of GDP to defence spending over the next decade, which in turn means that opportunities remain within the burgeoning defence sector.

BAE shares have risen by 52% over the last year versus 20.4% for the wider FTSE100, and by 127% over the last three years. The resultant higher valuation has done little to deter investors, with the market consensus remaining at a buy and the price reaction at the open a further reflection of optimism for the foreseeable future.