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BAE Systems - profits strong, but guidance weaker

George Salmon | 21 February 2019 | A A A
BAE Systems - profits strong, but guidance weaker

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BAE Systems plc Ordinary 2.5p

Sell: 550.80 | Buy: 551.20 | Change -1.60 (-0.29%)
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BAE Systems has delivered underlying earnings per share of 42.9p, up 2%, and expects mid-single digit growth in 2019. Both figures sit neatly in-line with analyst expectations.

However, free cash flow of £615m is behind consensus forecasts, and the phasing of spending next year means guidance for both free cash and net debt is weaker than expected.

The shares fell 5.6% on the news.

The final dividend is 13.2p per share, helping the full year payout rise 2% to 22.2p.

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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 has seen several large orders finally come through. Qatar, Canada, and Australia have called on BAE to boost their air force and navy, and President Trump has ramped up US defence spending.

That's not to say it'll be plain sailing from here. Trump has been known to change his mind on policy, while international condemnation of the Saudi Arabian government over the death of journalist Jamal Khashoggi led to speculation that BAE's multi-billion dollar deal with its Air Force could be under threat. We'll be keeping an eye on the planned deal to sell The Kingdom a further 48 Typhoon aircraft.

While the US President may still be fond of hulking great machines that make big bangs, the nature of modern warfare has changed the landscape. A laser guided missile is little use against a cyber-threat, and 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 the time being we think BAE offers good income-paying potential. The balance sheet looks robust enough, despite the sizeable pension deficit adding an unwanted burden, while the multi-billion pound order book gives it excellent revenue visibility.

The shares offer investors a prospective yield of 4.5%, and analysts expect the dividend and earnings to increase in the coming years, although of course there are no guarantees.

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Full year results details

Reported sales dipped slightly to £18.4bn, as extra US business was more than offset by lower Typhoon production. The non-repeat of a £384m impairment against Cyber & Intelligence last year has helped reported profits rise. However, underlying cash profits as measured by earnings before interest, tax and amortisation (EBITA) were 2.3% lower at £1.9bn.

New contract wins included a £5.1bn Typhoon and Hawk programme for Qatar, a £3.2bn servicing contract in Saudi Arabia and £1bn in US ship repair deals. Total order intake rose 39.6% to a record £28.3bn. In turn, this helped BAE's order backlog rise to £48.4bn.

The group's net debt position rose to £904m, as a result of lower operating cash flows and a slight increase in capital expenditure, to £464m. The net pension deficit reduced by £100m to £3.9bn.

Cyber & Intelligence EBITA nearly doubled to £111m despite a weaker top line, as cost reduction plans kicked in. The Electronic Systems business also delivered higher EBITA, up from £541m to £606m as a result of F-35 programme and higher classified activity.

In Air, completed Typhoon production activity on European, Saudi and Oman contracts led reported sales down 7% to £6.7bn. With margin also dropping, cash profits fell 11.1% to £859m.

US Platforms & Services underlying sales growth of 5% was behind expectations, and the group took impairments against commercial shipbuilding. Cash profits fell too, down from £237m to £210m.

Maritime EBITA dipped 16.7% to £209m. While the Dreadnought submarine and Type 26 programmes continue to ramp-up, Carrier trading was at a more conservative level than planned.

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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.