Stephen Bland reappraises BAE Systems (LSE: BA) in light of its failed merger with EADS.
A few weeks ago I wrote about my opposition to the planned merger of UK weapons manufacturer BAE Systems (LSE: BA) with the European company EADS, which is predominantly a civilian aircraft manufacturer. I hold BAE in my high-yield portfolio (HYP), and have in addition written about it as a value play in the past.
Bad feeling
My principal reason for being against the merger was the likely gunning down of BAE's dividend by EADS, which has a lower yield and would have ended up with a majority 60% of the new company. The merger terms stated outright that BAE's dividend would be held for 2013 compared with 2012 whereas the analysts' consensus forecast for BAE alone was predicting a modest rise for 2013. For 2014 and later, I had the distinct feeling from the nebulous wording of the merger statement -- although it didn't admit this outright -- that a cut, or at best a further hold, may have been due for former BAE shareholders.
Clearly, this was not good news for a HYPer, and neither for a value player, either. Another factor influencing my strong opposition to the merger was that BAE is exclusively a weapons and related support equipment manufacturer. I like that. Killing people is probably the oldest profession, and selling people the wherewithal to do so is consequently quite attractive as a business in which to invest, although there's always competition. In contrast, civilian aircraft manufacture stinks to me, and consequently would have diluted BAE's excellent business from my viewpoint.
Also, any kind of business arrangements with Europe always give me a funny feeling where it matters, in the wallet, so give me the USA any day if we have to do big mergers at all. It's a cliché but I think it's true that for us, the UK, the Atlantic is narrower than the Channel.
Good news
Anyway, yesterday, BAE announced the good news that the merger was off and today it released an interim management statement for the period 1 July to 10 October, so I thought it apposite to re-appraise the share in the light of its now solo existence. This will, as usual from me, be from a value or possibly HYP attitude, so let's look at the fundies, which is what matters here.
I'll start with yield, as this was one of the strongest features. The 2012 dividend forecast is 19.5p of which the interim of 7.8p has already been declared. At 327p this puts them on a forward yield of 6.0%. Pretty good, but it gets a bit better because the 2013 forecast is for slightly more at 20.3p, giving an expected yield of 6.2% for that year.
Net tangible assets we can forget, unfortunately, because this figure was highly negative at the latest accounts, being the half year to 30 June. Also offering no value support is the net debt of £1,230m at that date. Thus my two lead value indicators, assets and net cash, give us nothing.
Forecast earnings per share (eps) for 2012 on the analysts' normalised basis shows a consensus of 40.8p, which is down about 11% from the actual 2011 figure. This gives a forward price-to-earnings (P/E) ratio of 8.0, which is modest. For 2013 the prediction is 41.7p, making a P/E of 7.8, slightly better but bear in mind that a further out forecast must be less reliable than a closer one.
For 2012 generally, the directorspeak comments in the management statement that trading for the period has been in line with expectations at the time of the half-year results, suggesting that a good level of credibility may be attached to the forecasts of eps and dividends for this year at least. Further good news is given by operating cash inflow in that a higher level is anticipated for 2012 owing to the receipts from their major Saudi contract.
Foolish final thoughts
For value investing, when it comes to big caps, regular readers of my stuff will know that I'm prepared to ease up on some value features, including my lead tests of assets and net cash, as a trade-off for the sheer size of such shares. That's because they are so closely and widely followed that any undervalue on any of my criteria alone is likely to be outed in the end and less downside minimisation may be required.
That view is what lies behind my investment in another big cap, Aviva (LSE: AV), which has a very high and I believe ultimately unsustainable yield, meaning that either the dividend will be cut or the share will rise substantially. Naturally, I think the latter is far more likely than the former, but the point is that it is almost the yield alone that causes me to call this a value play 'buy'. and I regard it as a decent HYP holding as well.
For BAE, I take a similar view. Its yield and P/E seem to me just a bit too high and just a bit too low respectively. It's not perhaps quite as attractive a value play as Aviva, but there may be some mileage in it.
For an HYP holding, I find BAE highly desirable because its yield is far above average, its payout has grown, and there aren't a lot of big-cap pure weapons manufacturers from which to choose, bearing in mind that diversification is the most fundamental and inviolable of all my HYP construction rules.
Where is the UK's leading dividend stock-picker investing today? The identities of Neil Woodford's favourite blue chips are revealed in this free Motley Fool report -- "8 Shares Held By Britain's Super Investor".
Further Motley Fool investment opportunities:
> Stephen owns shares in Aviva and BAE Systems.
