Here’s why I believe the BAE Systems share price could be set for a rebound

Rupert Hargreaves explains why he believes it’s time to buy BAE Systems plc (LON: BA) ahead of a recovery in the share price.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Over the past 12 months, shares in BAE Systems (LSE: BA) have slipped nearly 9%, excluding dividends, underperforming the FTSE 100 by several percentage points. 

However, I believe this weakness is temporary and the shares are set for a near-term recovery as the group reinforces its position in the global defence market. 

Market performance 

BAE’s performance over the past year is disappointing, but the firm’s long-term record of value creation is more impressive. Indeed over the past three years, the stock has returned 10.8% per annum, including dividends, outperforming the FTSE 100 by 3% a year. It’s also registered a similar performance over the past five years. 

The recent underperformance has taken shares in BAE back to where they were at the end of 2017, suggesting the market is ignoring the City’s 2018 growth projections. Analysts have pencilled in earnings per share (EPS) gains of 18% for 2018, followed by an expansion of 9.2% for 2019. These figures suggest the stock is trading at an undemanding forward P/E of 12.7, falling to 11.6 for 2019.

That said, the City’s numbers clash with BAE’s own growth estimates. Back at the beginning of August, management told investors to expect flat earnings this year, after winning a $26bn contract to build warships for Australia.

Last year, the company reported normalised EPS of 36.4p. Based on this figure, the stock is trading at a forward P/E of 15.1. 

Best in the sector

A P/E of 15.1 is not too expensive for an international business with a steady order book, in my view. On top of the attractive valuation, the stock also supports a market-beating dividend yield of 4.2% on a forward basis. 

What’s more, BAE’s valuation is below the defence sector average. Peer Chemring (LSE: CHG) trades at a dearer 16.6 times forward earnings, and has a more mixed-growth outlook. 

After a troubled few years, beset by contract delays and restructuring efforts, analysts had expected the business to return to growth in 2018. Unfortunately, a fatal explosion at its Salisbury factory in August wrote off this expectation. Now, due to lost production and clean-up costs, EPS are projected to fall nearly 40% year-on-year. However, EPS are expected to rebound in 2019 — barring any unforeseen developments. The City is forecasting EPS of 11.7p for 2019, giving a 2019 P/E of 16.5. 

If I had to choose between these two sector peers, I would buy BAE for my portfolio over Chemring. Not only is Chemring more expensive, but the company’s business is unpredictable. Sales at the group have actually fallen by half over the past five years. 

BAE offers a much more stable growth platform with its multi-billion dollar international projects. Further, the shares are deeply undervalued compared to the rest of the global defence industry. Shares in US peer General Dynamics, for example, change hands for 18 times forward earnings. 

On this basis, I rate BAE shares a ‘buy’ as I think they’re due a near-term recovery. 

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.

Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

Young female business analyst looking at a graph chart while working from home
Investing Articles

The abrdn share price is down 23% in the last year, should I buy?

Asset management firms have had a rough time lately, but with the abrdn share price down heavily, is now the…

Read more »

Hand of a mature man opening a safety deposit box.
Investing Articles

If I’d invested £5k in red hot BAE Systems shares 5 years ago here’s what I’d have today

BAE Systems shares have smashed the FTSE 100 for years and Harvey Jones is keen to buy more as they…

Read more »

Investing Articles

How I’d aim to earn £16,100 in passive income a year by investing £20k in a Stocks and Shares ISA

Harvey Jones is building a portfolio of high-yielding FTSE 100 dividend stocks that should give him a high and rising…

Read more »

Investing Articles

Down 8% in a month! The BP share price is screaming ‘buy, buy, buy’ at me right now 

When crude oil falls, the BP share price invariably follows. Harvey Jones is wondering whether this is the right point…

Read more »

Bus waiting in front of the London Stock Exchange on a sunny day.
Investing Articles

Could the 9.8% M&G dividend yield get even bigger?

Christopher Ruane reckons that, although the M&G dividend yield is already close to a double-digit percentage, it could get better…

Read more »

Investing Articles

How much passive income could I earn by putting £380 a month into a Stocks and Shares ISA?

Christopher Ruane explains how he'd aim to turn a Stocks and Shares ISA into four-figure passive income streams each year.

Read more »

Investor looking at stock graph on a tablet with their finger hovering over the Buy button
Investing Articles

2 passive income stocks I’m buying before an interest rate cut

With the market expecting interest rates to fall in August, time might be running out for investors looking to buy…

Read more »

Investing Articles

If I’d bought Rolls-Royce shares a year ago, here’s what I’d have now

Rolls-Royce shares have been the big FTSE 100 success story of the past 12 months and more. And there's still…

Read more »