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BAE Systems - on track to meet full year expectations

Sophie Lund-Yates, Equity Analyst | 19 May 2021 | A A A
BAE Systems - on track to meet full year expectations

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BAE Systems plc Ordinary 2.5p

Sell: 566.20 | Buy: 566.40 | Change 0.00 (0.00%)
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Management has reiterated its full-year guidance for sales growth of 5% - 7% and underlying operating profit growth over 10%.

BAE said the Air, Maritime, Electronic Systems and Intelligence and Security divisions are performing strongly. US Platforms and Services is seeing some positive momentum, with combat vehicle production ramping back up.

Order intake is ahead of expectations with Electronic Systems signing on contracts worth $925m, Platform & Services securing around $900m, and Maritime adding $1.7bn of new contracts.

President Biden's defence budget of $715bn is largely flat compared to this year. Long-term defence commitments have been renewed in the UK.

The group's final dividend of 14.3 pence per share will be paid in June.

The shares were broadly flat following the announcement.

View the latest BAE share price and how to deal

Our view

It seems the Covid clouds are clearing for the majority of BAE's businesses, putting it firmly on track to meet its growth goals for the year. That comes even as air travel remains muted - which makes it harder to sell BAE's commercial flight control products.

That's the beauty of a huge, diversified defence company like BAE. The group's primarily in the business of manufacturing and delivering heavy duty military equipment - think fighter jets and aircraft carriers. A significant portion of existing defence contracts are deemed critical, and overall, that gives BAE great visibility over its multi-billion pound order book and revenues. Now that the US and UK have confirmed their commitment to maintaining defence spend, that path is even clearer.

The reliable revenue streams that carried BAE through the pandemic meant the firm could focus on future growth rather than survival. The group used the opportunity to buy US-based Military Global Positioning System and Airborne Tactical Radio businesses. The GPS business, which protects against navigational interference, cost $1.9bn while the communications purchase was worth $275m. The two compliment the group's existing navigation and communication offerings and improved sales latter-half of the year. Further cost-savings should be realised this year as well. All of this makes the purchase a worthwhile endeavour in our view.

BAE's also in the process of beefing up its tech-heavy Cyber & Intelligence as technology continues to play a larger role in warfare. The group brought two new businesses under its umbrella in March, a nod to management's commitment to aligning the business with changing customer needs. Cyber & Intelligence is responsible for just a fraction of BAE's total revenue right now, but could become a much more vital growth engine moving forward.

The coast isn't totally clear, though.

Cash flow has always been a thorn in BAE's side, and 2020 pension contributions squashed that figure even further. Management confirmed that it's seen "material reductions" in its deficits so far this year, but we'll reserve judgement for when we have a clearer picture of exactly what "material" means.

BAE's position as a critical defence supplier should continue to hold it in good stead. And reliable revenue streams are a very enviable asset in the current environment. We also note the valuation isn't too demanding. Investors should be prepared to take a long-term view as the commercial side of BAE's business is still facing some uncertainty.

The author holds shares in BAE Systems plc

BAE key facts

  • Price/Earnings ratio: 10.5
  • 10 year average Price/Earnings ratio: 11.0
  • Prospective dividend yield (next 12 months): 4.9%

All ratios are sourced from Refinitiv. Please remember yields are variable and not a reliable indicator of future income. Keep in mind key figures shouldn't be looked at on their own - it's important to understand the big picture.

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Full Year Results- 25/02/2021 (all figures underlying unless otherwise stated)

Full year sales, excluding the impact of exchange rate movements, rose 4% to £20.9bn. Underlying EBITA - which measures operating profit excluding interest, tax and amortisation payments, rose 1% £2.1bn.

Sales in the Air division (37.9% of group revenue) rose 6% to £7.9bn, driven by F-35, Typhoon activity and continued progress on the Qatar Typhoon and Hawk aircraft programme. A strong second half helped offset earlier Covid-related challenges. Flat profit margins (return on sales) of 11.9% meant EBITA rose at a similar rate to sales, rising 6.1% to £941m. The group is continuing to manage its supply chain to mitigate the impacts of Covid-19, including the downturn in the commercial aircraft market.

Electronic Systems sales rose 2.7% to £4.6bn, half of which was driven by acquisitions. Covid lowered demand for commercial products, and sales for these rose around 3%. Commercial revenues are more profitable, so the declines in this area meant overall EBITA fell slightly to £684m (2019:£687m), despite the overall increase in sales.

US Platforms & Services saw sales increase 5% to £3.5bn, reflecting continued momentum in US combat vehicles. The pandemic resulted in delivery delays on most vehicle programmes, and there were "significant interruptions" and delays to Ship Repair. This hurt efficiency and made each transaction more expensive, bringing the return on sales down to 5.6% from 8%. This fed into a 27% decline in EBITA to £195m.

Increased construction activity on Dreadnought Class submarines drove a 4.5% uptick in sales to £3.3bn in the Maritime division. Overall efficiency improved as the Dreadnought Class submarines programme continued to advance, leading to a 0.8bps increase in return on sales to 9.4%. This helped EBITA rise 14.2% to £306m.

Cyber intelligence sales rose 4.6% to £1.8bn, driven by Government Services and US & Intelligence Security business, which offset declines in Financial services. Restructuring at Applied Intelligence was behind a 49.5% increase in EBITA to £136m.

Free cash flow more than halved to £367m due to a £1bn pension contribution. Excluding the impact of that contribution, free cash flow rose to £1.4bn (2019:£850m).

A £1bn bond issuance to fund the pension scheme and Electronic Systems acquisitions increased the group's net debt position to £2.7bn, from £743m in 2019. The group payed £1.7bn into its pension scheme in 2020 (2019: £461m).

The group's order backlog stands at £45.2bn (2019: £45.4bn) Air orders account for around half of this. The backlog represents roughly 80% of next year's expected sales.

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This article is original Hargreaves Lansdown content, published by Hargreaves Lansdown. Unless otherwise stated estimates, including prospective yields, are a consensus of analyst forecasts provided by Refinitiv. 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.