BAE Systems (LSE: BA) had been going sideways until the events of 2022. Now, the Russian invasion of Ukraine has helped send the BAE Systems share price up 43% in the past 12 months.
A defence stock spike started the exact same day the tanks rolled in, which is not really surprising. While the war is extracting an enormous human cost, it’s also destroying billions of pounds in defence equipment. And someone is going to have to replace it in the coming years.
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In BAE’s AGM update on 5 May, Ukraine got no specific mention. Chief executive Charles Woodburn did, however, speak of “opportunities to further enhance the medium-term outlook as our customers address the elevated threat environment.“
Increasing NATO spend
Being a bit more specific, BAE said “In Europe, the significant step up in German defence expenditure is important for long-term defence funding. We see other nations increasing or likely to increase their defence budgets to address the threat environment and for NATO countries to move to, and even beyond, their 2% of GDP commitments.“
As well as the obvious potential financial benefits to BAE, I can see a non-financial one too. This year’s developments might help take some attention away from the company’s association with Saudi Arabia. There’s been a lot of criticism of companies supporting autocratic regimes with shameful human rights violations.
I don’t see this making an immediate difference to the bottom line, though. It all takes time to get new defence contracts in place and for elevated profits to arrive. And Western governments don’t exactly have huge amounts of cash to spend in the current economic climate.
2022 outlook
BAE’s outlook for the 2022 full year remains modest. The company expects annual sales to increase between 2% and 4%, leading to an underlying earnings-per-share (EPS) increase of 4% to 6%.
BAE’s dividend has been erratic, but cash flow can be uneven for companies operating with multi-year projects. Still, the board expects to see more than £1bn of free cash flow in 2022. And it’s predicting cumulative free cash flow of more than £4bn between 2022 and 2024.
A 5% EPS increase would put the price-to-earnings (P/E) ratio at 15 on the current BAE Systems share price. That’s pretty much in line with the FTSE 100‘s long-term average.
Buy now?
On that basis, I reckon it’s fair value. And I regret all those years when I’ve judged BAE shares to be undervalued but never bought them. It’s always been a case of “Yeah, that’s a buy, but not right now because I’m seeing others I want.”
Perhaps it’s because I’m an eternal optimist. Hoping for world peace while investing for war? Well, maybe that’s actually a sensible hedge.
What’s the downside of buying BAE shares right now? I’m always wary of investing in a company that’s on a bit of a bandwagon roll. When everyone sees the bullish potential in a stock, and its price is climbing, that’s so often a prelude to a medium-term fall.
I still, however, think investors could do well buying BAE Systems shares for the long term.
