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BAE Systems - on target for the full year

Nicholas Hyett | 7 November 2019 | A A A
BAE Systems - on target for the full year

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BAE Systems plc Ordinary 2.5p

Sell: 493.10 | Buy: 493.30 | Change 0.00 (0.00%)
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In a brief trading update BAE said it continues to expect mid-single digit growth in earnings per share this year and £3bn in free cash flow over the 2019-2021 period.

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.

After some tough years in global defence markets, BAE has finally seen several large orders come through. Qatar, Canada, and Australia have called on BAE to boost their air forces and navies, and President Trump has ramped up US defence spending.

That's not to say it'll be plain sailing from here and defence is increasingly in the political limelight.

Labour has, for better or for worse, made it clear defence wouldn't be a priority if it were to enter government. And a disorderly Brexit could see money diverted away from the defence budget regardless of who wins the coming election. The current US administration hasn't always been the most consistent on policy either.

Meanwhile, 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 Eurofighter Typhoon jets for around £10bn.

It doesn't help that while the US President may still be fond of hulking great war machines, 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.

That explains the emergence of the Cyber & Intelligence business, which encompasses both national and commercial cyber security. It's not yet making a substantial contribution to group profit, and has been forced into some restructuring. But if all goes to plan it'll be a growth driver in the future.

Cash flow from the core business has proven rather lumpy of late, so BAE will need this to improve if it's to hit its target of £3bn+ in free cash by 2021.

However, we still think BAE offers good income-paying potential. The multi-billion pound order book provides excellent revenue visibility, while the balance sheet looks robust, despite the sizeable pension deficit adding an unwanted burden.

The shares offer investors a prospective yield of 4.1%, and analysts expect the dividend and earnings to increase in the coming years, although of course there are no guarantees.

Register for updates on BAE Systems

Third quarter trading update

The F-35 programme continues to ramp up, with around 140 aft-fuselage sets expected to be completed this year and full production on track for next year.

There continues to be substantial activity in the UK Maritime business, including the Dreadnought, Offshore Patrol Vessel and Type 26 programmes. The Queen Elizabeth Class aircraft carrier programme is approaching completion, with HMS Prince of Wales commencing sea trials in September. New ship programmes for the Australia and Canadian navies are underway.

Production is increasing across several US Combat Vehicle projects, including Amphibious Combat Vehicles and Armoured Multi-Purpose Vehicles. The division continues to win new projects.

Electronic Systems has continued to make good progress, including an initial $184m award for BAE's Advanced Precision Kill Weapon Systems (APKWS).

The low bond yield environment continues to weigh on the groups pension scheme, and that is expected to present a headwind in 2020.

Find out more about BAE Systems shares including how to invest

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.