BAE Systems plc (BA.) Ordinary 2.5p

BAE Systems full-year sales grew to £25.3bn, up 9% ignoring currency impacts and ahead of the group’s prior guidance. All segments delivered growth, with maritime seeing the biggest uplift as funding for the Dreadnought submarine programme accelerated.

Underlying operating profit rose 9% to £2.7bn, in line with sales growth as margins remained broadly flat.

Free cash flow improved from £2.0bn to £2.6bn. Net debt, excluding lease liabilities, roughly halved to £1.0bn.

Since year-end, the £4.4bn acquisition of Ball Aerospace has been completed.

In 2024, BAE’s sales and underlying operating profits are expected to grow 10-12% and 11-13% respectively. This includes a nearly full-year contribution from the acquisition.

A final dividend of 18.5p per share has been announced, taking the full-year total to 30p, up 11.1% on the prior year.

The shares were broadly flat following the announcement.

Our view

BAE Systems has moved from strength to strength, with full-year revenue and underlying operating profits coming in ahead of its prior guidance. The company manufactures heavy-duty military equipment like fighter jets, aircraft and submarines, and recent global events have increased demand for BAE's products.

Despite being a UK-based company, a whopping 42% of its sales came from the US in 2023, making it the largest single contributing region. On an absolute basis, US military spending trumps any other country in the world, so having large exposure to this market is proving very beneficial.

But BAE isn’t stopping there. It sealed the deal on its £4.4bn acquisition of US-based Ball Aerospace in February, which should further increase its foothold on that side of the pond. Ball has unique in-space capabilities, which is seen as a major growth area in the defence industry. The deal looks like a good fit to us and should help drive top-line and margin growth, although nothing is guaranteed.

The group booked £37.7bn worth of orders in 2023, taking the order backlog up to a record £69.8bn. And because these are typically long-cycle orders, with revenues spread over several years, it gives BAE multi-year revenue visibility.

But keep in mind that profitability hinges on an ability to estimate future costs. The long-term nature of many contracts means that the related risks and costs can change over time. Currently, its turbulent energy costs and potential supply chain issues that management has called out are the main trip hazards.

These risks are currently being navigated well and profits have moved in the right direction. The group's also using some of its financial firepower to acquire other businesses which can slot straight into its portfolio and begin contributing to revenue and profit growth right away. Although, given the size of the Ball Aerospace acquisition, it'll likely only be small bolt-on purchases that get added to the portfolio in the near future.

At year-end, the balance sheet was in good shape. The Ball Aerospace deal will push debt levels higher, but we don’t see this as a major issue given the group’s healthy cash flows and demand outlook. However, it does mean we could see the rate of share buybacks slow in the near to medium term.

We think BAE's in good shape to deliver on its long-term growth strategy and the market appears to agree with a valuation some way above the long-term average. Reliable revenue streams are a very enviable asset and help underpin a prospective dividend yield of 2.6%. Please remember no dividend is ever guaranteed.

The author holds shares in BAE Systems.

Environmental, social and governance (ESG) risk

The aerospace and defence sector is high-risk in terms of ESG. Product governance and business ethics are key risk drivers. Carbon emissions from products and services, data privacy and security and labour relations are also contributors to ESG risk.

According to Sustainalytics, BAE System’s management of ESG risk is strong. It has a product safety policy and chain of accountability and assesses safety throughout product development. It has a board-level committee that oversees business ethics risks and has improved disclosure regarding human rights. However, disclosure regarding quality management standards and external certifications are lacking, and BAE should improve reporting on business ethics incident investigations. Employee development programmes are strong and the group has committed to net zero with interim targets in place.

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