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BAE Systems - full year results in line with guidance

Sophie Lund-Yates, Equity Analyst | 20 February 2020 | A A A
BAE Systems - full year results in line with guidance

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BAE Systems plc Ordinary 2.5p

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Underlying sales rose 7% to £20.1bn and underlying EBITA - which measures operating profit excluding interest, tax and amortisation charges, rose 5% to £2.1bn. That includes a £50m boost from accounting changes, and growth in all divisions but the smaller Cyber & Intelligence and HQ divisions.

The group announced a final dividend of 13.8p per share, which takes the total payment for the year up 4.5% to 23.2p.

BAE said results are in line with guidance, and the shares rose 1.7% following the announcement.

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Our view

BAE's been a beneficiary of a growing US defence budget.

That's because BAE is in the business of manufacturing and delivering heavy duty military equipment - think fighter jets and aircraft carriers. President Trump's substantial defence splurge has been good for business, and BAE seems to think this level of spending can be sustained in the near-term.

Other nations have been ramping up spending too. 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.

A supportive macro environment is good news for the already substantial order book, but there are other moving parts to keep an eye on.

Modern warfare is changing, leading to more importance being placed more on cyber tools and smart technology, and less on mammoth pieces of kit.

The Cyber & Intelligence business should be an important driver for future growth, but it's not yet making a substantial contribution to group profit. The more tech-savvy warfare of the future is also behind BAEs efforts to bolster its second biggest division, Electronic Systems. This department produces "commercial and defense electronics for flight", as well as systems used in electronic warfare, surveillance and communications intelligence.

This area of the business is set to be boosted by the $2bn acquisition of Collins Aerospace's Military GPS business, and Raytheon's Airborne Tactical Radios division. The deal would also increase exposure to American end markets and present an opportunity for cost savings. It's worth remembering though, raising debt levels to pay for deal means there's a chance extra returns to shareholders could be delayed.

Looking ahead, we're also mindful the current US administration hasn't always been the most consistent on policy, while tensions with Saudi Arabia mean a deal to sell The Kingdom a further 48 Eurofighter Typhoon jets for around £10bn could be under threat.

Cashflow is the final thorn in BAE's side, having not been exemplary. Although new plans to tackle an onerous pension deficit could provide this area with a boost in the years ahead, but there are no guarantees.

Overall we still think BAE has some real strengths. The multi-billion pound order book provides excellent revenue visibility, while the balance sheet still looks robust. Should the deals go ahead, we can see the potential for real benefits, particularly the extra US exposure.

The shares currently offer a prospective yield of 3.8%.

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Full year results (all figures underlying unless otherwise stated)

Higher production activity on the new Typhoon and Hawk programme for Qatar helped Air sales rise 11% to £7.5bn. EBITA rose 3.3% to £887m, although return on sales dipped slightly due to last year's one -off benefit for completing the Oman Typhoon contract.

US Platforms and Services saw EBITA increase 27.1% to £267m, reflecting a 6% (constant currency) rise in sales to £3.3bn. The improvement includes the successful ramp up of US combat deliveries during the second half. The division also recorded an order backlog of £5.8bn, compared to £5.4bn last year. BAE expects sales to rise by high-single digit percentages in 2020, reflecting increased volumes from the US Combat Vehicle backlog and ship repair.

Within Electronic Systems sales of £4.4bn were up 7% excluding the impact of exchange rates, driven by growth in the defence business and increased classified activity. EBITA of £687m represented a 15.5% return on sales, at the higher end of BAE's guidance range. The order backlog of £6bn was a record high.

Maritime sales rose 5%, ahead of guidance, to £3.1bn. However the order backlog of £8.6bn was behind 2018's £9bn, as further awards for funding on the Dreadnought submarine programme was offset by weakness in other programmes. EBITA rose 28.2% to £268m.

Cyber & Intelligence sales were broadly flat at £1.7bn, and EBITA dipped £20m to £91m which reflects a restructuring charge in the Applied Intelligence business.

Improved profitability helped free cash flow improve to £850m, compared to £615m in 2018. Net debt fell to £743m (2018: £904m).

At the end of October the group's pension deficit stood at £1.9bn, and a new deficit recovery plan is in place, "under which a one-off payment of £1bn is to be made in the coming months, with approximately £240m of funding payable in the scheme year ending 31 March 2020 and approximately £250m by 31 March 2021." The group intends to raise new debt to make the one-off payment.

Looking ahead BAE expects earnings per share to grow by mid-single digit percentage compared to this year's EPS of 45.8p.

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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.