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The Pros And Cons Of Investing In BAE Systems plc

Stock market selections are never black-and-white decisions, and investors often have to plough through a mountain of conflicting arguments before coming to a sound conclusion.

Today I am looking at BAE Systems (LSE: BA) (NASDAQOTH: BAESY.US) and assessing whether the positives surrounding the firm’s investment case outweigh the negatives.

US budget agreement improves earnings outlook

The global defence sector has been fighting a rearguard battle in recent years, as the consequences of the 2008/2009 banking sector have smashed government armaments budgets, particularly in the key markets of North America and the UK — BAE Systems sources more than 35% of group sales from the US alone.

However, news last week that US legislators had agreed to raise the defence budget to $520.5bn in 2014 extinguished fears of heavy near-term cuts, and is up from $518bn this year. Signs that the US economy is finally on the mend also bodes well for future budgets and thus earnings potential for the world’s arms builders.

… but Eastern promise fails to deliver

Further afield, however, the company’s fortunes in the Middle East took a bit of a hiding this week. Firstly, BAE Systems announced that the United Arab Emirates had withdrew from discussions with the British Government concerning the sale of Eurofighter Typhoon aeroplanes, a development that could cost the firm billions of pounds in revenues.

As well, BAE Systems announced that it had still not resolved price negotiations with Saudi Arabia over the previous sale of Typhoon jets under the Salam agreement. The company confirmed that this will adversely affect earnings to the tune of 6p to 7p per share in 2013.

New markets revving higher

Still, the weapons builder continues to roll off the contract wins in these exciting new geographies, and inked a £1.5bn deal with the Saudis earlier this month for the supply of guided weapons as well as service and parts for the country’s Typhoon fleet.

BAE Systems is also making huge headway in other emerging markets, and advised in its latest interims that “international market activity remains vibrant with multiple opportunities being pursued,” the firm having etched out £5bn worth of new orders from March to the start of October. With three of its home markets outside of the US and UK — that is, India, Australia and Saudi Arabia — the firm is clearly banking on fresh markets to deliver future growth.  

A stunning stock selection

In my opinion, BAE Systems is a great pick for those seeking an excellent growth play at great value, the company trading at rock-bottom P/E multiples of 10.2 and 10.5 for 2013 and 2014 respectively. I believe that the firm’s position as a class-leading defence play should keep its stream of contract wins running, increasingly so from red-hot emerging markets, and thus drive earnings higher well into the long term.

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> Royston does not own shares in BAE Systems.