ii view: BAE Systems nudges profit forecast higher

Robust demand and a dividend yield of over 4.5% are reason to be positive.

Third-quarter trading update

• Small upgrade to full-year earnings per share expectation
• Full-year sales forecast left unchanged

Chief executive Charles Woodburn said: 

"We have continued to deliver a resilient performance in line with our expectations for a strong second half, thanks to the outstanding efforts of our employees in these challenging times. From a position of strength, the actions we took in quarter two to enhance our resilience are working well as reflected in our guidance, ensuring we continue to deliver on our customer priorities, whilst keeping our employees safe. Demand for our capabilities remains high and we recognise our role not only in supporting national security, but also in contributing to the economies of the countries in which we operate."

ii round-up:

Arms maker BAE Systems (LSE:BA.) today slightly raised its full-year earnings expectation, given high demand for its products and recent German government approval to buy a further 38 Typhoon fighter aircraft.

At its late-July first-half results, the company expected adjusted earnings per share to fall by a mid-single-digit percentage from last year's 45.8p. It now expects they will be "slightly higher than previously guided". Sales are still expected to grow by a low-single-digit percentage.

BAE shares rose by more than 1.5% in UK trading, leaving the fall year-to-date at around 16%. Shares for rival QinetiQ Group (LSE:QQ.) are down around a fifth while shares for Babcock International (LSE:BAB) have more than halved in 2020.

A good operational performance at BAE plants and an expected lower tax rate should offset negative foreign exchange headwinds, we're told. BAE products include jet fighter components, navy guns and radar. Its Air division, which contributes towards both the US F-35 fighter and Europe’s Typhoon jet, remains its biggest by sales, generating around a third of annual revenues.

Most of its operations are doing well, with over 90% of employees working. A focus on ramping up F-35 production at both its Air and Electronic Systems divisions continues, while the first of its new multi-purpose armoured vehicles have been delivered to the US Army. At its Marine division, the fifth and final offshore patrol vessel, HMS Spey, was accepted by the Ministry of Defence in October.

At its full-year 2019 results, BAE deferred a decision on the final dividend. Then, at July’s first-half 2020 interim numbers, it declared both a 13.8p final 2019 and 9.4p interim 2020 per share per payments. 

Full-year results are scheduled for 25 February. 

ii view:

BAE operates across the five divisions of air, electronic systems including components for commercial aircraft, platforms and services making combat vehicles, naval maritime and cyber and intelligence. It employs over 85,000 personnel across 40 countries. The defence industry is driven by politics and government appetite for spending. As such, it is somewhat volatile in nature, with order flow difficult to predict. 

In tandem with a diverse product range, BAE also attempts to sell its products to a differing selection of countries. In 2019, sales to the US accounted for nearly half of overall sales, with the UK second at around a fifth and the now politically scrutinised Saudi Arabia third at just over 14%. 

For investors, the strain on government finances under measures to address the pandemic, and possible resulting defence spending cuts further down the line, warrant consideration. A change of US government could also have budget implications. That said, relatively frosty relations between the US and China and Russia offer a positive, if undesired, backdrop. It's certainly not one for most ethical investors, but a now reinstated dividend and historical income yield of over 4.5% (not guaranteed) means BAE looks justifies its place in a balanced and diversified investment portfolio. 

Positives: 

• Order backlog of over £45 billion
• Attractive dividend (not guaranteed)

Negatives:

• US political uncertainty
• Pandemic is now stressing government borrowing levels

The average rating of stock market analysts:

Buy