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BAE Systems - Global defence spending underpins results

Nicholas Hyett | 8 November 2018 | A A A
BAE Systems - Global defence spending underpins results

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BAE Systems plc Ordinary 2.5p

Sell: 801.80 | Buy: 802.20 | Change 4.80 (0.60%)
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A short trading update from BAE systems confirmed the group's on course to meet full year guidance, with underlying earnings per share expected to be in line with 2017.

An interim dividend of 9p will be paid at the end of November.

The shares were broadly unmoved following the announcement.

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Our view

BAE makes military equipment. The MoD is a big client, but it also has long-standing relationships with the US and Saudi Arabian governments.

Defence markets have hardly been booming in recent years. But BAE chief exec, Charles Woodburn thinks a change is in the air. In full year results, he said, that with a 'positive outlook for defence budgets in a number of key markets, we have a strong foundation to deliver growth and sustainable cash flow.'

His confidence has been backed up by several large orders finally coming through. Qatar, Canada, and Australia have called on BAE to boost their air force and navy, and President Trump is ramping up US defence spending.

International condemnation of the Saudi Arabian government over the death of journalist Jamal Khashoggi led to some speculation that BAE's multi-billion dollar deal with the Saudi Air Force could be under threat. There's been no comment on that, but it's certainly one to keep an eye on.

While the US president may still be fond of hulking great machines that make big bangs, 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 them too.

Defence companies will never be redundant, we fear, but they may need to update their armoury. That explains why BAE is investing in its Cyber & Intelligence business, which encompasses both national and commercial cyber security. It's not yet making a substantial contribution to group profit, but if all goes to plan it'll be a growth driver in the future.

For now, BAE's multi-billion pound order book gives it excellent revenue visibility, which should help support the dividend.

The shares offer investors a prospective yield of 4.3%, and analysts expect the dividend and earnings to increase in the coming years, although of course there are no guarantees.

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Trading Update

The UK budget has confirmed the government's commitment to defence spending. The group continues to work on its substantial Air and Maritime contracts for the UK government, including the F-35, Offshore Patrol Vessels and Type-26 programmes.

The Astute and Dreadnought submarine programmes are reported to be delivering improved performances, while flight trials on HMS Queen Elizabeth are continuing off the US coast. The Applied Intelligence businesses is expected to break even this year.

BAE has stressed there is relatively little UK-EU trading and movement of EU nationals into and out of BAE Systems' UK businesses. The resulting near-term Brexit impacts across the business are likely to be limited.

Major defence programmes have been confirmed in the US. The backlog remains strong with the group focussed on dealing with challenges associated with rapid growth. The US ship repair business has been further strengthened by the $146.3m contract to modernise the USS Gettysburg.

The International business won a $5bn Typhoon and Hawk contract with Qatar, and naval agreements with the Australian and Canadian governments are in final stage negotiations.

Full year results will be announced on the 21 February.

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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 for more information.