As the Paris Air Show kicks off Monday, aeronautical and engineering stocks are once again expected to attract interest, particularly following the recent news of a merger between US giants United Technologies and Raytheon. This is set to create a $120bn behemoth and has many people asking what other potential defence combinations could be in the offing?
This is one reason why BAE Systems(LSE: BA) could be worth looking at. The UK’s largest defence contractor is one of a few such companies that could truly appeal on the international stage, already having a large presence in the American market, where defence, money and politics are the most institutional of bedfellows. But there are other good reasons to consider it too, I believe.
Saudi Concerns
Not that everything is rosy. One of the key areas that has been weighing on BAE’s share price has been its exposure to the Saudi market, particularly as tensions between the Kingdom and the UK escalated following the killing of journalist Jamal Khashoggi last year. The company currently gets about 14% of its total sales from Saudi Arabia, including its largest single export contract of 72 Eurofighter Typhoons. It has admitted that tensions between the two countries could put its ability to support the jets – which would bring in some $2.5bn a year – at risk.
On the domestic front, political concerns brought about by Brexit and around the implications for BAE if a Jeremy Corbyn-led labour party won a general election at some point are weighing on the company’s stock. The politician is famously against the UK’s nuclear deterrent, a large concern for BAE as it is the manufacturer of the Dreadnought nuclear submarines the UK uses.
Dividends and order book
Despite these worries, the firm has a lot to offer investors. Most notably the company has consistently offered a steady and strong dividend, its latest yielding 4.6%. Dividend growth for investors as been about 2% per annum for the past five years, while profits for the company, though dipping in 2017, have been fairly steady, with a margin of around 5%.
BAE has about $48bn worth of orders currently on its books, with a number of significant wins recently adding to this optimistic outlook. These include confirmation of an order for more Eurofighter Typhoon’s from Qatar, as well as a deal to build navy frigates for Australia that could bring in £20bn over the project’s 30-year life.
Significantly, the cash generated by this order book has been key to offsetting the company’s large pension commitments, though admittedly the pension spending doesn’t leave much in the way of spare cash for future expansion at the moment. CEO Charles Woodburn admitted his operational improvements are a process of “evolution” rather than “revolution”.
Finally, though it is true the company has large exposure to Saudi Arabia, it currently gets about 42% of its sales from the US – where military spending and investment are generally expected to grow – and about 21% from the UK. As mentioned, this British number could take a hit if Jeremy Corbyn gets to Downing Street, but most analysts are suggesting that the current share price is already factoring in the potential loss of Dreadnought contracts.
With all this in mind, I am looking for a near-term dip to put some money where my mouth is on this one.
