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BAE Systems - Cuts announced, outlook unchanged

George Salmon | 10 October 2017 | A A A
BAE Systems - Cuts announced, outlook unchanged

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BAE Systems plc Ordinary 2.5p

Sell: 519.20 | Buy: 519.60 | Change -7.20 (-1.37%)
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Recent trading has been in line with management expectations, and BAE's outlook for 2017 remains unchanged. The shares were broadly unmoved on the news.

The trading statement also confirmed up to 1,925 jobs will be cut, as the group strives for higher levels of efficiency and competiveness.

The bulk of the reduction will be in the UK Platforms & Services divisions, as a result of lower UK Typhoon and Hawk production rates. The division is to be merged with the P&S International division in a new Air & Maritime unit.

Our view:

2016's explosive political events have significant read-across for BAE.

The sell-off in sterling after the Brexit vote means the group's significant overseas revenues are now worth more to UK investors. Meanwhile, Donald Trump's victory in the US election has raised hopes that a series of bumper orders could be on the way.

While not yet sanctioned, President Trump has proposed a $54bn boost to the US defence budget. Significant military action thankfully appears some way off, but hopes are high that BAE will still benefit from a jump in demand.

In the wider context, defence markets have been tough for years, so we could see some improvement as austerity eases. However, while the US president may still be fond of hulking machines that make big explosions, the nature of modern warfare might have leapfrogged modern weaponry. A laser guided missile is little use against a cyber-threat. A battle tank is a tad blunt against an insurgency, whilst cutting edge jet fighters are only really necessary if your opponent has jets too.

Defence companies will never be redundant, we fear, but we may be at an inflection point, where their traditional weapon platforms of tanks, jets, subs and missiles are less important than data processing and surveillance capabilities.

The Cyber & Intelligence business, encompassing both national and commercial cyber security, is an area the group is keen to grow, but it may be a while before this division makes a substantial contribution to group profit.

For the time being though, the group's £42bn order backlog and its established relationships with the US, Saudi and the UK governments give the group excellent revenue visibility, which should support the dividend. BAE offers investors a prospective yield of 3.7%, with analysts expecting both the dividend and earnings to increase steadily in the coming years, although of course there are no guarantees.

Half year results:

The group's largest division, UK Platforms & Services, saw operating profits rise 3% to £406m. Sea trials on the HMS Queen Elizabeth, the first of the two ships in the aircraft carrier programme, commenced in June. The same month also saw the group finalise an MOD contract for an initial batch of three Type 26 frigates.

Boosted by exchange rate moves, US Platforms & Services operating profit rose 25% to £99m, with profits in the international business rising 10% to £161m. High profile work includes the US Army's Armoured Multi-Purpose Vehicle contract, which has a potential value of £900m. Work is underway between the UK and Saudi Arabian governments to finalise the details after agreeing to extend the Saudi British Defence Co-operation Programme out to 2021.

The electronic systems division, which includes flight controls and electric drive systems, saw operating profit rise 23.5% to £247m, boosted by growing demand for the Advanced Precision Kill Weapon System laser-guided rocket system. The small Intelligence & Cyber division made a profit of £20m.

Looking ahead, underlying earnings per share for 2017 is expected to be 5% to 10% higher than 2016's 40.3p. The net pension deficit reduced to £5.9bn, from £6.1bn at the full year stage. Net debt currently stands at £1.7bn, and is expected to end the year below the c. £1.5bn at which it closed out last year.

Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Thomson Reuters. These estimates are not a reliable indicator of future performance. Yields are variable and not guaranteed. Investments rise and fall in value so investors could make a loss.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.

This article is not advice or a recommendation to buy, sell or hold any investment. No view is given on the present or future value or price of any investment, and investors should form their own view on any proposed investment. This article has not been prepared in accordance with legal requirements designed to promote the independence of investment research and is considered a marketing communication. Non-independent research is not subject to FCA rules prohibiting dealing ahead of research, however HL has put controls in place (including dealing restrictions, physical and information barriers) to manage potential conflicts of interest presented by such dealing. Please see our full non-independent research disclosure for more information.