[FREE] BAE Systems (BA.L) Equity Research Report
Our Take on BAE Systems
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Business Overview:
BAE Systems plc is a global defence, aerospace, and security company headquartered in the UK. Founded in 1999 through the merger of British Aerospace and Marconi Electronic Systems, BAE Systems has grown to become one of the world's largest defence contractors.
At the core of BAE Systems' business model is its ability to design, manufacture, and support advanced defence systems across air, maritime, land, and cyber domains. The company's diverse portfolio and strong relationships with government customers, particularly in the US, UK, Saudi Arabia, and Australia, provide a solid foundation for sustained growth. BAE Systems operates through five main segments:
Electronic Systems (25% of H1 2024 sales): Electronic Systems encompasses a wide range of advanced electronic solutions developed in both the US and UK. This segment produces electronic warfare systems that protect military platforms from various threats, alongside navigation systems for military and commercial applications. It also creates electro-optical sensors for surveillance and targeting, as well as military and commercial digital engine and flight controls. The division specialises in precision guidance and seeker solutions for missiles and smart munitions, next-generation military communications systems and data links, and persistent surveillance capabilities. With the recent acquisition of Ball Aerospace, the segment has expanded its offerings to include space electronics, spacecraft, and ground systems. Additionally, it develops electric drive propulsion systems, further broadening its technological portfolio.
Platforms & Services (16% of H1 2024 sales): Operating primarily in the US, Sweden, and the UK, Platforms & Services focuses on the manufacture and upgrade of combat vehicles, weapons, and munitions. Key products include the Armoured Multi-Purpose Vehicle (AMPV) and Amphibious Combat Vehicle (ACV) for the U.S. military, the CV90 family of combat vehicles, and various artillery systems. This segment also provides crucial services such as naval ship repair and sustainment activities. A unique aspect of this division is its management and operation of two government-owned ammunition plants for the U.S. Army, underlining its importance in the defence supply chain.
Air (30% of H1 2024 sales): The Air segment is at the forefront of combat aircraft and future air system technologies. It plays a significant role in the production of the Eurofighter Typhoon and the F-35 Lightning II, providing both airframes and electronic systems. The segment is deeply involved in the Global Combat Air Programme (GCAP), working on developing next-generation fighter aircraft. Beyond new production, it offers support and upgrades for in-service aircraft fleets and operates the FalconWorks organisation, which conducts research into innovative aerospace technologies.
Maritime (22% of H1 2024 sales): Maritime comprises the Group's UK-based maritime and land activities, along with its Australian operations. This segment is responsible for major submarine and ship build programs, as well as their ongoing support. Key projects include the Astute and Dreadnought class submarines for the UK Royal Navy, the Type 26 frigate, and the Hunter class frigate for Australia. The division also develops autonomous and unmanned maritime systems, provides naval ship repair and modernisation services, and delivers maritime combat systems and radar integration solutions.
Cyber & Intelligence (9% of H1 2024 sales): Cyber & Intelligence consists of the US-based Intelligence & Security business and the UK-headquartered Digital Intelligence business. This segment covers the Group's cyber security activities for National Security, Central Government, and Government Enterprises. It provides a range of services including secure government communications, intelligence analysis, and mission support for defence and security agencies. The division also offers data analytics, digital transformation services, and develops modelling, simulation, and synthetic training environments for military applications.
Key Indicators
BAE Systems' revenue is largely based on long-term contracts with government customers, making order intake and backlog key indicators of its future revenue and market position. These metrics offer critical insights into the company’s growth prospects:
Order Intake: £15.1 billion for H1 2024. This reflects the value of new orders received during the period, highlighting BAE’s ability to secure new business and maintain competitiveness. Strong order intake suggests potential for future revenue growth.
Order Backlog: £74.1 billion as of 30 June 2024 (up from £69.8 billion at the end of 2023). The backlog represents orders that have been received but not yet fulfilled, providing visibility into future revenues. A growing backlog indicates long-term stability and growth potential.
These metrics are particularly relevant due to the defence industry's long-term contracts and government spending cycles. Increased global tensions and rising defence budgets further drive demand for BAE’s products, supporting its growth and reinforcing its position as a global leader in defence and aerospace.
Financial Reporting and Sales vs. Revenue
BAE Systems' financial reporting reflects the complex nature of its business and the long-term contracts typical in the defence industry. The company distinguishes between 'sales' and 'revenue' in its financial statements, which is important for investors to understand:
Sales: BAE Systems defines sales as the total income generated from all its operations, including its share of revenue from joint ventures and subsidiaries. This metric provides a comprehensive view of the company's overall business activities and is often used by management to assess performance across segments.
Revenue: Revenue, as reported in accordance with International Financial Reporting Standards (IFRS), only includes income from BAE Systems' consolidated subsidiaries, excluding the company's share of revenue from joint ventures. This is the figure that appears in the statutory accounts.
The difference between sales and revenue is primarily due to BAE Systems' significant joint venture operations, particularly in its Air segment. These joint ventures contribute to sales but are not fully consolidated in the revenue figure. The calculation to arrive at revenue from sales is as follows:
Sales - Group's share of revenue from equity accounted investments + Subsidiaries' revenue from equity accounted investments = Revenue
This dual reporting approach provides both a management view (sales) and a standardised accounting view (revenue) of the company's performance. It allows for a more nuanced understanding of BAE Systems' business, particularly in segments where joint ventures play a significant role.
For example, in the first half of 2024, BAE Systems reported sales of £12,662 million, while revenue was £11,036 million. This difference largely reflects the impact of joint venture activities, particularly in the Air segment where programs like the Eurofighter Typhoon involve significant collaboration with other defence contractors.
Geographic Presence:
BAE Systems' global footprint spans key defence markets worldwide, with operations concentrated in five main regions. The company's sales and revenue breakdown by customer location for the first half of 2024 is as follows:
UK (25% of sales)
The company's home market remains a cornerstone of its business, generating £3,390 million in sales and £3,212 million in revenue. BAE Systems plays a crucial role in supporting the UK's defence capabilities across air, maritime, and land domains.
US (44% of sales)
As the largest defence market globally, the US is BAE Systems' most significant region, contributing £5,961 million in sales and £5,983 million in revenue. The company's strong presence is bolstered by its US-based subsidiaries and the recent acquisition of Ball Aerospace.
Kingdom of Saudi Arabia (11% of sales)
A key international market for BAE Systems, Saudi Arabia accounted for £1,469 million in sales and £1,411 million in revenue. The company's long-standing relationship with the Kingdom includes support for air force fleets and other defence systems.
Europe (excluding UK) (10% of sales)
European markets, including NATO allies, generated £1,403 million in sales and £844 million in revenue. BAE Systems' presence in Europe is reinforced by collaborations on programs like Eurofighter Typhoon and missile systems through MBDA.
Australia (4% of sales)
An increasingly important market, Australia contributed £594 million in sales and £591 million in revenue. BAE Systems' role in major programs like the Hunter Class Frigate and potential involvement in AUKUS underscores its growing significance in the region.
Other markets (6% of sales)
The remainder of BAE Systems' global footprint, including Canada, Qatar, and various countries in Asia and the Pacific, collectively accounted for £582 million in sales and £436 million in revenue. These diverse markets represent opportunities for future growth and expansion.
This geographic diversity not only provides BAE Systems with a robust and balanced portfolio but also positions the company to capitalise on increasing defence spending across multiple regions, driven by evolving global security challenges.
Moat Analysis:
BAE Systems has established a strong moat in the defence sector, supported by several key factors that bolster its market leadership and create significant barriers for competitors.
Strong Customer Relationships and Long-Term Government Contracts
BAE Systems has cultivated deep-rooted relationships with government customers, particularly in major defence markets, which help form its competitive moat. These relationships, built on a proven track record of delivering large-scale, complex defence projects, have fostered significant trust and enhanced the company's reputation over time. This trust translates into tangible business advantages, as evidenced by BAE's impressive order backlog of £74.1 billion, which provides substantial visibility on future revenues.
The nature of defence contracting, characterised by long-term agreements with government clients in key markets such as the US, UK, Saudi Arabia, and Australia, creates formidable barriers to entry for potential competitors. These contracts typically span decades and involve intricate, mission-critical systems that require ongoing support and upgrades. As a result, clients face high switching costs, both in terms of financial investment and operational continuity, making it challenging to transition to alternative suppliers.
Moreover, the depth of these relationships extends beyond mere transactional interactions. BAE Systems often becomes deeply integrated into its clients' defence infrastructures, providing not just products but also crucial services, maintenance, and strategic advice. This level of integration, combined with the sensitive nature of defence technology, makes BAE an indispensable partner to its government clients.
The longevity and strength of these relationships also position BAE Systems advantageously for future contracts. The company's demonstrated reliability, understanding of complex government procurement processes, and ability to navigate intricate regulatory environments give it a significant edge in securing new business. This creates a virtuous cycle where past performance and existing relationships pave the way for future opportunities, continually reinforcing BAE's market position and competitive advantage in the global defence industry.
Scale and Diversification
BAE Systems' expansive operational footprint spans multiple business segments and key markets worldwide, providing the company with significant advantages in scale, diversification, and global reach. This diverse portfolio not only allows BAE Systems to benefit from economies of scale but also significantly reduces risk through diversification, shielding the company from fluctuations in individual markets or segments.
Strategic Partnerships
BAE Systems has established a robust network of strategic partnerships that significantly contribute to its competitive advantage in the global defence industry. At the forefront of these collaborations is the Eurofighter consortium, where BAE Systems works alongside Airbus and Leonardo to produce the advanced Eurofighter Typhoon. This partnership allows BAE to share development costs and risks across multiple nations, access broader market opportunities, and leverage combined technological expertise. Similarly, BAE's 37.5% stake in the MBDA joint venture, shared with Airbus and Leonardo, solidifies its position in the missile systems market, providing diversified revenue streams and access to cutting-edge missile technology.
The company's leadership in the Type 26 Global Combat Ship Program, selected by the UK, Australia, and Canada, demonstrates its ability to forge international partnerships that spread development costs, ensure long-term revenue streams, and facilitate knowledge sharing across nations. As a tier 1 partner in the Lockheed Martin-led F-35 program, BAE Systems manufactures critical components for every F-35 globally, gaining access to advanced stealth and avionics technologies while securing long-term revenue from one of the world's largest defence programs.
Beyond these major collaborations, BAE Systems maintains strategic partnerships with universities and research institutions, funding PhD programs and research projects to access emerging technologies and talent pipelines. The company also actively seeks industry collaborations, such as its partnership with Microsoft for digital transformation initiatives and collaborations with AI and robotics companies for autonomous systems development. These diverse partnerships enable BAE Systems to spread risks and costs associated with large-scale defence projects, access new markets and technologies, maintain a diverse portfolio, and stay at the forefront of technological innovation. By leveraging these strategic alliances, BAE Systems strengthens its market position, reduces individual project risks, and ensures access to a broad range of technologies and expertise, all of which contribute significantly to its competitive moat in the global defence industry.
High Regulatory Barriers
The defence industry is heavily regulated, requiring compliance with security clearances, export controls, and government oversight. BAE Systems’ ability to navigate this regulatory environment further strengthens its competitive position by creating significant obstacles for new entrants.
Technological Expertise and Integrated Capabilities
BAE Systems maintains its position as a global leader in the defence industry through consistent investment in research and development, coupled with its ability to deliver integrated solutions across multiple domains. This combination of cutting-edge technology and comprehensive capabilities forms a significant part of the company's competitive moat.
Research and Development Focus:
BAE Systems consistently invests in R&D, focusing on critical areas that shape the future of defence technology:
Electronic Warfare: The company is a world leader in electronic warfare systems, with its products equipping over 80% of U.S. military fixed-wing aircraft and 95% of U.S. Army rotary-wing aircraft. BAE's advanced EW systems provide superior situational awareness and protection in complex battlespaces.
Autonomous Systems: BAE Systems is at the forefront of developing autonomous and unmanned technologies for air, land, and sea applications. This includes projects like the Taranis combat drone demonstrator and autonomous maritime systems.
Precision-Guided Weapons: The company continues to innovate in laser-guided and GPS-guided munitions, enhancing accuracy and reducing collateral damage in military operations.
Space Solutions: With the acquisition of Ball Aerospace, BAE Systems has significantly expanded its space capabilities, including spacecraft systems, space electronics, and Earth observation technologies.
Artificial Intelligence and Machine Learning: BAE Systems is integrating AI and ML into various defence applications, from threat detection to autonomous decision-making systems.
Cyber Security: The company's Digital Intelligence business unit focuses on developing advanced cyber defence capabilities for both military and civilian applications.
Integrated Capabilities:
BAE Systems' ability to deliver end-to-end solutions across multiple domains also gives it a significant competitive advantage:
Multi-Domain Integration: The company can provide integrated solutions that span air, maritime, land, cyber, and space domains, offering customers comprehensive defence capabilities.
Full Lifecycle Support: From initial design and development to manufacturing, integration, and through-life support, BAE Systems can manage the entire lifecycle of complex defence systems.
Cross-Domain Synergies: The company leverages technologies and expertise across different domains, creating innovative solutions that address evolving defence challenges.
Global Presence: With operations in key markets worldwide, BAE Systems can tailor its integrated offerings to meet specific regional requirements and leverage local expertise.
Collaborative Approach: The company's ability to work effectively with other defence contractors, government agencies, and academic institutions enhances its capacity to deliver integrated solutions.
This combination of technological expertise and integrated capabilities allows BAE Systems to:
Maintain a competitive edge in a rapidly evolving defence landscape
Meet the complex, multi-faceted needs of modern military operations
Offer unique, high-value solutions that are difficult for competitors to replicate
Adapt quickly to changing defence priorities and emerging threats
By continually investing in cutting-edge technologies and leveraging its broad capabilities, BAE Systems strengthens its market position and builds long-term relationships with key defence customers around the world.
Intellectual Property
BAE Systems holds a substantial portfolio of patents and proprietary technologies. While specifics may not always be disclosed, this intellectual property is a key asset that differentiates the company from its competitors and provides a foundation for future innovation.
Skilled Workforce
With around 99,800 employees, many of whom possess specialised skills and security clearances, BAE Systems commands a highly skilled workforce that is difficult for competitors to replicate. This depth of talent is essential for delivering complex defence projects.
Management and Incentives:
BAE Systems' management team is led by Group Chief Executive Officer Dr. Charles Woodburn, whose leadership has been crucial in driving the company's position as a global leader in defence, aerospace, and security systems. The executive team comprises experienced professionals from diverse backgrounds, ensuring a well-rounded approach to managing the company's complex operations across multiple countries and sectors.
Key Management:
Dr. Charles Woodburn (Group Chief Executive Officer): Woodburn has been leading BAE Systems since 2017. His background in the oil and gas industry, including 15 years at Schlumberger, brings valuable experience in managing large-scale, technologically complex operations. Woodburn's leadership has been instrumental in maintaining BAE Systems' position as one of the world's largest defence contractors.
Tom Arseneault (President and CEO of BAE Systems, Inc.): Arseneault leads the U.S.-based subsidiary of BAE Systems, overseeing operations in the United States, United Kingdom, and Sweden. His role is crucial in managing the company's significant presence in the U.S. defence market.
Brad Greve (Group Finance Director): Greve is responsible for the financial management of the entire BAE Systems group, playing a key role in strategic financial decisions and reporting.
Gabby Costigan MBE (Group Managing Director, Business Development): Costigan leads BAE Systems' business development efforts globally, leveraging her background as a former CEO of BAE Systems Australia and her 21-year career in the Australian Army.
Incentive Structure:
BAE Systems has implemented a comprehensive incentive structure designed to align management interests with long-term shareholder value. The compensation package includes:
Base Salary: Competitive basic salaries benchmarked against industry standards.
Annual Bonus Scheme:
Maximum opportunity ranges from 160% to 225% of salary for top executives
One-third of the net annual bonus is deferred into BAE Systems shares for 3 years
Performance metrics include financial targets (75-80%) and other strategic objectives
Long-Term Incentive Plan:
Performance measured over a 3-year period
Awards based on total shareholder return (TSR) and earnings per share (EPS) targets
Shares vest in three equal instalments at the end of years 3, 4 and 5
Share Incentive Plan:
Employees can purchase Partnership Shares through payroll deductions
Company provides free Matching Shares on a 1:1 basis for Partnership Shares purchased, up to £75 per month
Shares are purchased from pre-tax salary, providing tax advantages
Other Benefits:
Car allowance (£25,000 per annum for CEO, £20,000 for other top executives)
Pension contributions
Healthcare coverage
Life and disability insurance
Insider Ownership and Recent Activity:
Insider ownership at BAE Systems is very low, with individual insiders owning approximately 0.066% of the company's shares (1,981,693 shares). This low level of insider ownership is not something we usually look for, as it could potentially indicate a misalignment between management's interests and those of shareholders.
Recent insider trading activity has also shown a trend towards selling:
Charles Woodburn (CEO): Sold shares worth £10,909,325.46
Tom Arseneault (President and CEO of BAE Systems, Inc.): Sold shares worth £1,501,528.24
This significant insider selling could be viewed negatively by the market, as it might suggest that those with the most intimate knowledge of the company's prospects are reducing their stakes. However, it's worth noting that there has also been some insider buying, albeit on a smaller scale in the last 24 months amounting to 19,131 shares for £254,740.48.
Context for Share Sales:
It's important to note that the recent significant share sale by CEO Charles Woodburn was primarily motivated by personal financial planning, specifically to finance the purchase of a multi-million pound property. Additionally, part of the sale was to cover tax obligations arising from the vesting of shares awarded under the company's long-term incentive plan.
The timing of Woodburn's sale coincided with a rise in BAE Systems' share price, reportedly linked to increased defence spending due to heightened tensions in the Middle East. This allowed him to maximise the value of the shares sold, netting almost £1 million extra due to the price increase.
Despite the large sale, there's no indication that Woodburn has lost confidence in BAE Systems. In fact, he has spoken positively about the company's performance and outlook, with BAE Systems raising its full-year adjusted profit growth expectations from 11-13% to 12-14%.
Employee Share Scheme:
It's noteworthy that BAE Systems has an employee share scheme that holds about 4.16% of shares (124,648,994 shares), which represents a more significant ownership stake than individual insiders. This scheme helps to align the interests of a broader base of employees with those of shareholders.
Institutional Ownership:
The majority of BAE Systems' shares (82%) are held by institutions rather than individual insiders, which is common for large, publicly traded companies. This high level of institutional ownership can provide stability but also means that these large shareholders have significant influence over the company's direction.
In conclusion, although insider selling and low insider ownership could be seen as red flags, the company’s incentive structure—including deferred bonuses and long-term incentive plans—aligns management’s interests with long-term shareholder value. The CEO's recent large stock sale and the employee share scheme add important context, suggesting that insider transactions may not necessarily reflect a lack of confidence in the company’s future performance.
BAE’s Capital Allocation Strategy
BAE Systems' approach to capital allocation is designed to balance growth investments, shareholder returns, and financial stability. The company's strategy focuses on five key areas:
Research and Development: BAE Systems prioritises investment in R&D to maintain its technological edge. The company focuses on areas like electronic warfare, autonomy, laser-guided weapons, counter UAS, synthetic training, electrification applications, and space solutions. This investment is crucial for staying competitive and winning future contracts.
Organic Investment: The company continues to invest in its facilities and workforce to support future growth. This includes capital expenditure focused on maritime, munitions, and combat vehicle production capacity. For example, BAE is investing more than £160 million in advanced manufacturing capabilities and a new customer test and acceptance centre for its Hägglunds business in Sweden.
Maintaining Financial Strength: BAE Systems aims to maintain an investment grade credit rating and ensure operating flexibility. This includes meeting pension obligations and maintaining a strong balance sheet. As of June 30, 2024, the company had a cash position of £2.8 billion and a net debt (excluding lease liabilities) of £6.1 billion.
Shareholder Returns: The company is committed to a progressive dividend policy, with 20 consecutive years of dividend growth. In the first half of 2024, BAE Systems declared an interim dividend of 12.4p per share, an 8% increase from the previous year. Additionally, the company has been executing share buyback programs. The £1.5 billion program announced in July 2022 was completed in July 2024, and a new £1.5 billion program was launched immediately after.
Strategic Acquisitions: More details below.
Major Acquisitions
Here's a summary of the major acquisitions, their timing, and their impact:
Tracor (1999)
One of the most significant parts of the newly created BAE Systems North America
Contributed to BAE's expansion in the US market
United Defence (2005)
Acquired for approximately $4.2 billion
Major manufacturer of combat vehicles, artillery, and naval guns
Merged into BAE Systems Land & Armaments operating group
Strengthened BAE's position in the US defence market
Armor Holdings (2007)
Purchased for approximately $4.532 billion
Manufacturer of military, law enforcement, and personnel safety equipment
Resulted in large contracts, including a $2.24bn contract for mine-resistant ambush-protected (MRAP) vehicles
MTC Technologies (2008)
Acquisition finalized in June 2008
Further expanded BAE's presence in the US market
Atlantic Marine (2010)
Purchased for $352 million
Expanded BAE's marine support capabilities
Ball Aerospace (2024)
Acquired for $5.5 billion
Largest acquisition in BAE Systems' history
Enhances BAE's capabilities in space, C4ISR, and missile systems
Malloy Aeronautics (2024)
British technology business specializing in heavy lift drone and aeronautical technologies
Strengthens BAE's position in uncrewed aerial systems (UAS)
Success and Impact
The acquisitions have generally been successful in expanding BAE Systems' capabilities and market presence:
US Market Expansion: Acquisitions like Tracor, United Defence, and Armor Holdings significantly increased BAE's footprint in the US defence market, which is "by far the largest defence market".
Financial Growth: The United Defence and Armor Holdings acquisitions led to large contracts, contributing to BAE's financial growth.
Technological Advancement: The recent acquisition of Ball Aerospace is expected to enhance BAE's capabilities in space and cyber domains, positioning the company at the forefront of industry convergence and innovation.
Revenue Growth: Ball Aerospace is projected to increase its sales by 10% annually over the next five years, potentially reaching around $4 billion by the end of the decade.
Portfolio Diversification: Acquisitions have helped BAE Systems diversify its product offerings, moving beyond traditional military hardware into areas like electronic systems, cyber security, and intelligence.
Market Positioning: The Ball Aerospace acquisition is expected to deepen BAE's relationship with key customers like NASA and boost its environmental monitoring and surveillance capabilities.
Overall, BAE has demonstrated a disciplined approach to capital allocation, which has resulted in strong financial performance, increased shareholder returns, and strategic growth.
Financials and Rough Valuation:
Key financial highlights include:
Profitability:
Underlying EBIT: £1,393 million in H1 2024, up 13% year-over-year
Underlying earnings per share: 31.4p in H1 2024, up 7% year-over-year
Return on sales: 10.4% in H1 2024
Growth:
Sales: £13,399 million in H1 2024, up 13% year-over-year
Order intake: £15.1 billion in H1 2024
Order backlog: £74.1 billion as of 30 June 2024, up from £69.8 billion at the end of 2023
Balance Sheet Strength:
Cash and cash equivalents: £2,831 million as of 30 June 2024
Net debt (excluding lease liabilities): £6,088 million
Free cash flow: £219 million in H1 2024 down from £1,070 million in H1 2023 due to timing of customer advances.
Efficiency:
EBIT margin was 10.4% in H1 2024, consistent with 10.5% in H1 2023.
Order Backlog Growth:
BAE Systems' order backlog grew to £74.1 billion by H1 2024, up 6.2% from £69.8 billion at the end of 2023.
Dividend Growth:
Interim dividend increased by 8% to 12.4p per share.
Expected growth rates for key metrics going forward:
Sales Growth: BAE Systems has upgraded its full-year 2024 guidance to 12-14% growth. Over the next few years, analysts expect growth in the high single to low double digits, driven by increased defence spending globally.
Underlying EBIT Growth: The company expects 12-14% growth for 2024. In the medium term, growth might be expected to be in line with or slightly above sales growth due to operational efficiencies.
Order Intake: This can be lumpy due to the nature of large defence contracts, but the overall trend is expected to be positive given the current geopolitical climate.
Dividend Growth: BAE Systems has a policy of long-term sustainable dividend growth. The 8% increase in the interim dividend suggests continued growth, potentially in the mid to high single digits annually.
Free Cash Flow: While H1 2024 saw lower free cash flow due to timing of customer advances, BAE Systems expects over £6.0 billion of free cash flow for the three-year period ending 2024.
EPS Growth: The company expects 7-9% growth in underlying earnings per share for 2024. Over the medium term, EPS growth might be expected to be in line with or slightly above EBIT growth.
These projections are based on the company's guidance and general industry trends. Actual results may vary based on geopolitical events, contract timing, and other factors.
Below are our back-of-the-napkin intrinsic value estimates based on a 10% discount rate and a 5-year timeframe:
Bull: 14% EPS Growth Rate, 22 PE - £13.4 Per Share
Base: 10% EPS Growth Rate, 19 PE - £9.75 Per Share
Bear: 6% EPS Growth Rate, 16 PE - £6.8 Per Share
The Thesis:
BAE Systems is a high-quality company with a strong competitive moat, effective capital allocation, and is well-positioned for sustained growth and value creation in the coming years. Its growth is underpinned by a robust, diversified business model and favourable industry dynamics, particularly in a world increasingly shaped by geopolitical conflict. The key factors that underpin our positive outlook include:
Operational Excellence: BAE's continued focus on operational efficiency and program execution, backed by a robust operating model, should drive margin expansion over time.
Strategic Investments: Ongoing investments in R&D, facilities, and strategic acquisitions (such as Ball Aerospace) are enhancing BAE's technological capabilities and market positioning.
Diverse Portfolio: The company's balanced mix across air, maritime, land, and cyber domains, coupled with its geographic diversity, provides resilience and multiple growth avenues.
Market Leadership: BAE's leading technology solutions and strong customer relationships in key markets like the US, UK, and Saudi Arabia position it well to capture increasing defence spending.
Growth Pipeline: A robust opportunity pipeline across global markets offers potential for further organic growth and market share gains.
Financial Strength: BAE's strong balance sheet and consistent cash generation support both reinvestment in the business and shareholder returns, including a progressive dividend policy and ongoing share buybacks.
Industry Tailwinds: Elevated geopolitical tensions and the need for technological modernisation in defence are driving increased government spending, benefiting major contractors like BAE.
While challenges such as supply chain pressures and project execution risks persist, we believe BAE Systems’ diversified portfolio, technological advantage, and strong order backlog provide a solid foundation for long-term value creation. The company’s ability to capitalize on these opportunities while maintaining operational discipline will be crucial to unlocking its growth potential. Although the current stock price reflects optimistic projections, we believe it still offers an opportunity to invest in a high-quality business at a reasonable valuation. The industry's inherent resilience further supports the decision to initiate a position, even if the stock is trading at slightly higher levels.
For full transparency, we do have a small position in BA.L at £12.70 a share. See the rest of our portfolio here:
Risks:
While BAE Systems has a strong market position and diverse portfolio, there are several risks that investors should be aware of. These risks, if not properly managed, could impact the company's long-term performance and valuation.
Geopolitical Risk: Dependence on government contracts exposes BAE to political changes and shifts in defence spending priorities. Potential impact from geopolitical tensions or changes in international relations.
Regulatory and Compliance Risk: Strict regulations in the defence industry could lead to increased compliance costs or penalties. Risk of contract cancellations or delays due to regulatory issues.
Economic and Budget Constraints: Vulnerability to government budget cuts or economic downturns in key markets. Potential delays or cancellations of major projects due to fiscal pressures.
Operational and Project Execution Risk: Complex, long-term projects carry risks of cost overruns, delays, or technical issues. Potential reputational damage from high-profile project failures.
Cybersecurity and Data Protection: As a defence contractor, BAE faces significant cybersecurity threats. Risk of data breaches or intellectual property theft.
Supply Chain Disruptions: Reliance on complex global supply chains exposes BAE to potential disruptions. Risk of material shortages or increased costs due to supply chain issues.
Technological Disruption: Need to continually innovate to stay ahead in a rapidly evolving technological landscape. Risk of disruptive technologies rendering current products obsolete.
Currency and Market Risk: Exposure to currency fluctuations due to global operations. Market risks associated with pension liabilities and investment portfolio.
Talent Acquisition and Retention: Competition for skilled engineers and technical experts in the defence sector. Risk of losing key personnel to competitors or other industries.
Environmental and Sustainability Concerns: Increasing pressure to address environmental impact and sustainability issues. Potential reputational risks associated with the defence industry's environmental footprint.
Disclaimer: The content provided in this newsletter is for informational purposes only and does not constitute financial, investment, or other professional advice. While we believe the information to be reliable, we cannot guarantee its accuracy. The opinions expressed are those of the author and do not necessarily reflect the views of Schwar Capital. Investing involves risk, including the possible loss of principal. Past performance is not indicative of future results. The author may or may not hold positions in the stocks or other financial instruments mentioned. Always do your own research or consult with a qualified financial advisor before making any investment decisions.
Dependence on saudi arabia turns me down. Aside from that, it’s the most diversified across all domains defense company I know. Got expensive after 2022.