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The Surprising Buy Case For BAE Systems Plc

Today I am looking at why BAE Systems (LSE: BA) (NASDAQOTH: BAESY.US) should not shake at the prospect of lower defence expenditure in the West.

A major player in many markets

In my opinion, there are a number of things to like about BAE Systems. Its diversified operations, spanning the construction of the next generation of aircraft carriers for the Royal Navy, through to providing real-time intelligence and analysis services, help to guard against overreliance on any one market.

The size and firepower of the company also allows it to latch onto the latest defence trends through organic development and M&A activity, from developing cutting-edge cyber-security through to producing counter-IED technology. But arguably the biggest feather in the company’s cap is that it is less susceptible to weakness in Western defence spend than many of its rivals.

BAE Systems is still a big puncher when it comes to providing technology to the British and United States governments, and the firm continues to deliver a steady stream of contract wins from traditional markets — indeed, the business’s Detica division inked a £40m, five-year deal with the UK Foreign & Commonwealth Office just this week to provide IT services and deliver massive efficiency savings.

On top of this, BAE Systems is also accelerating activity in other parts of the world to insulate itself from falling expenditure in the West, and orders from customers outside of the US and UK rose £500m in the first half of 2013 to £4.8bn. The company has a long-standing relationship with the Kingdom of Saudi Arabia, and is looking to expand into other key regions — in particular, the company is ploughing vast sums into India to turbocharge growth in its fifth self-proclaimed ‘Home Market.’

Since the last time I checked out defence giant BAE Systems, at the end of August, shares in the company struck fresh record peaks around 468p before settling lower again. Prices are back to where they were a couple of months ago, but shares are up almost a third since the turn of the year.

Despite this recent price strength, I believe that the defence play is still changing hands at attractive levels. The company currently changes hands on a P/E rating of 10.2 for 2013, just above the value benchmark of 10 and which looks a bargain when weighed up against the aerospace and defence sector’s forward reading of 13.5.

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And not only does BAE Systems offer sector-busting earnings prospects, the firm also offers a fantastic way to dig out chunky dividend income. The company currently offers a forward dividend yield of 4.5% -- far in excess of its aerospace counterparts' corresponding reading of 2.5% -- and I expect payouts to continue treading higher in coming years in line with earnings expansion.

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> Royston does not own shares in BAE Systems.