Interactive Investor

ii view: BAE Systems sticks to its target

8th November 2021 14:38

Keith Bowman from interactive investor

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Looking to Asia Pacific and with a dividend yield of over 4%. Buy, sell, or hold?

Third-quarter trading update

  • Full year guidance is unchanged

Chief executive Charles Woodburn said: 

“We're evolving our business to be well positioned for growth over the medium term alongside a focus on longer-term value drivers as we ramp up investment in advanced technologies and progress our sustainability agenda.”

ii round-up:

Arms maker BAE Systems (LSE:BA.) today underlined the benefit of its geographic diversity, although left its full-year sales and earnings estimates unchanged from that given back at its late July half-year results. 

BAE continues to expect both sales and earnings per share to growth between 3% to 5% compared to 2020, highlighting its customer exposure in Australia, the US and the UK, and Australia’s recent decision to switch from French bought submarines to a US option as strategically significant. 

BAE shares were little changed in UK trading, having risen by around 17% year-to-date. Shares for rival Babcock (LSE:BAB) are up by a similar amount over that time while shares for bid approached Meggitt (LSE:MGGT) have jumped by more than 60%. 

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.

Management flagged its supply chain resilience given the long-term programme positions and more stable forward visibility for long-lead items. Its backlog of orders supports growth over the medium term, with its pipeline of opportunities staying strong according to the board. 

As the largest defence provider in the UK and Australia and a top ten prime contractor to the US, management believes its portfolio is well positioned to benefit from increased defence spending in the Asia Pacific region through its Australia business. Both trade and military tensions have been growing between the US and China. 

In Europe, nations including Germany and France continue to increase their defence budgets to address the threat environment and move towards their 2% of GDP NATO commitments.

BAE’s recently outlined Environmental, Social and Governance (ESG) policies include a commitment to halt the handling of white phosphorus and plans to earn an accreditation as a real living wage employer. 

To date, it has completed £308 million of the £500 million share buyback programme announced at its July half-year results. Full-year results to the end of December are scheduled for the 24 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. 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 to a diverse selection of countries. In 2020, the US accounted for nearly half of total sales. Next came the UK, generating around a fifth, with the now politically scrutinised Saudi Arabia in third place at just over 14%. Australia accounted for under 4% of sales. 

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. Changes of government can also offer come with budget implications, while ethical concerns given the making of arms might be considered.

That said, relatively frosty relations between the US and China and Russia offer a positive if undesired backdrop. Add in a historic and forecast dividend yield of over 4% (not guaranteed), and BAE continues to justify its place in many balanced and diversified investment portfolios. 

Positives: 

  • Order backlog of over £44 billion
  • Attractive dividend (not guaranteed)

Negatives:

  • Arms manufacturing may generate ethical concerns
  • Pandemic is now stressing government borrowing levels

The average rating of stock market analysts:

Buy

These articles are provided for information purposes only.  Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties.  The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.

Full performance can be found on the company or index summary page on the interactive investor website. Simply click on the company's or index name highlighted in the article.

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