Is BAE Systems plc The #1 Value Play Right Now?

With shares remaining ultra-cheap, is BAE Systems plc (LON: BA) the ultimate value play?

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BAe SystemsOn the face of it, 2014 has been a disappointing year for BAE (LSE: BA) (NASDAQOTH: BAESY.US). That’s because it delivered a profit warning at the start of the year, its share price is down 2% during the course of the year and today it posted results that were behind the first half of last year. However, BAE could have a great future. Here’s why.

A Tough First Half

Certainly, the first half of 2014 was not much fun for BAE. Sales were 10.6% down on the same period last year, while profit was 7.5% lower. However, these numbers are in line with what the market expected and, as such, BAE’s share price is unmoved at the time of writing. Indeed, with the US undergoing its much talked about sequestration and the developed world making vast cutbacks to military budgets, it is perhaps unsurprising that BAE is having a tough time of it.

On the plus side, BAE expects improved sales throughout the second half of the year, but its full-year profit guidance continues to point to a decline of between 5% and 10%. Although disappointing, it could be argued that this would prove to be a decent result with the defence industry going through an extremely challenging period.

Looking Ahead

Indeed, the current challenges faced by BAE are highly unlikely to last over the long run. The defence industry has its ups and downs, but long-term demand is unlikely to significantly shift downwards. Looking at next year’s forecasts, BAE is expected to grow earnings by 3%, which is roughly in-line with the wider market and shows that a tough 2014 may not necessarily be followed by a difficult 2015.

A Great Value Play

Despite offering little in the way of excitement surrounding its short- to medium-term growth prospects at present, BAE could still deliver top-notch capital growth for investors. That’s because its current valuation appears to be unduly low, with BAE trading on a price to earnings (P/E) ratio of just 10.9. That’s 21% lower than the FTSE 100’s P/E of 13.8 and shows that BAE could be ripe for an upward rerating. Furthermore, BAE offers a top-notch yield of 4.8% that could go higher due to a relatively low dividend payout ratio of 53%.

Certainly, there may be more lumps and bumps ahead for BAE and it is unlikely to be a company for short-term investors. However, for income seeking, longer-term investors, it could prove to be a great value play that delivers strong future returns for its shareholders.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Peter Stephens owns shares of BAE Systems. The Motley Fool has no position in any of the shares mentioned.

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