ii view: BAE Systems remains top tip as order book grows

Third-quarter trading update to 30 September

• Order intake of £10 billion
• Year-to-date order intake of over £30 billion
• Full-year sales and profit guidance unchanged

Chief executive Charles Woodburn said: 

"Order flow on new and existing programmes, renewals on incumbent positions and progress with our opportunity pipeline remains strong. These underpin our confidence and visibility for good top line growth in the coming years, and we continue to reinforce our value compounding model with a sharp focus on operational performance and disciplined capital allocation."

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ii round-up:

Defence equipment maker BAE Systems (LSE:BA.) today detailed trading in line with its previously upgraded forecasts, as order intake during the third quarter remained strong. 

New orders to the end of September totalled £10 billion and included a £3.9 billion submarine build, a $800 million (£656 million) upgrade of US Bradley fighting vehicles and a $500 million artillery systems order from Sweden. That takes year-to-date orders to over £30 billion and means BAE still expects adjusted profit to grow by up to 8% from £2.48 billion in 2022. 

Shares in the FTSE 100 company rose marginally in UK trading having come into this news up by more than a quarter during 2023. Melrose Industries (LSE:MRO) is up by a similar amount, Chemring Group (LSE:CHG) is flat, while defence and civil aerospace engine maker Rolls-Royce Holdings (LSE:RR.) has more than doubled. The FTSE 100 index is little changed year-to-date.   

BAE’s products include components for jet fighter aircraft including both the US F-35 and Europe’s Typhoon jet, navy ships and submarines, armoured vehicles, along with electronic systems such as radar and cyber & intelligence systems and services. 

Operational investments year-to-date include advanced plans to expand its UK submarine facilities, progress on a new ship building facility in Glasgow, and a new investment in its munitions manufacturing capacity. Staff numbers have risen by 6%.

The regulatory process in relation to its previously announced £4.35 billion acquisition of Ball Aerospace continues to advance, with the deal on target to complete in the first half of 2024. The purchase increases BAE’s presence in the US and within the expected high-growth space domain. 

BAE's £1.5 billion share buyback programme, first announced in July 2022, continues to progress, with group returns during 2023 and including dividend payments expected to total £1.4 billion. 

Broker Morgan Stanley reiterated its ‘overweight’ stance on the shares post the update, flagging BAE as a ‘top pick’. Full-year results to the end of December are scheduled for 21 February.   

ii view:

BAE Systems is a major manufacturer of defence equipment. It employs more than 90,000 people across 40 countries. Aircraft related sales generate its biggest slug of revenues at around 38%, followed by electronic systems at 21%, naval or maritime equipment at 16%, platform and service sales including armoured vehicles at 15%, and cyber and intelligence the balance at under 10%. 

Geographically, the US accounts for close to half of all sales, followed by the UK at around a fifth, Europe and Saudi Arabia both at around a tenth each, and other countries including Australia and Qatar at under 5% each.    

For investors, ethical reasons may prevent some investors from buying shares in businesses involved in the manufacture of arms . Geopolitics and government appetite for spending regularly make demand volatile and difficult to predict. Changes of government can come with budget implications, while any acquisition and including its purchase of Ball Aerospace is not without risks.

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On the upside, conflicts in both Ukraine and Israel are increasing demand for defence equipment. Tensions between the West and China are also not to be ignored. BAE enjoys diversity of both product and geographical region, the Ball Aerospace acquisition pushes it into the space area, while the dividend payment remains progressive, rising for more than 15 years consecutively and offering a forecast dividend yield of over 2.5%. 

For now, and despite risks, this major defence contractor looks to remain worthy of its place in diversified investor portfolios. 

Positives: 

• Diversity of products and geographical sales
• Forecast dividend yield over 2.5%

Negatives:

• Arms manufacturing may generate ethical concerns
• Subject to government finances

The average rating of stock market analysts:

Buy