Defence stocks are highly popular shares with dividend investors. The predicable nature of arms spending — and the stability that this provides to profits — means that they can be a great way to generate long-term passive income.
BAE Systems (LSE: BA) is a defence company whose shares are in high demand today. Its share price has soared 46% since the start of the year as investors have piled into safe-haven stocks. It has also risen as the conflict in Ukraine has raised fears of a new Cold War.
BAE Systems is a share I’m considering buying to boost my own dividend income. Here, I’ll analyse its dividend forecast for the short to medium term, and explain why I’d snap it up for my portfolio.
Dividend yields
Let’s get the less-appealing news out of the way first. The soaring BAE Systems share price means that dividend yields through to 2023 now sit below the 3.9% FTSE 100 average.
For 2022 and 2023 the company’s yields stand at 3.3% and 3.5% respectively.
But this shortfall comes with a big caveat. Rapidly worsening economic conditions means that corporate earnings are coming under pressure and, as a consequence, many FTSE 100 dividends may up disappointing. This is not something I expect to happen at BAE Systems.
Predicted dividends here for the next couple of years are covered twice over by anticipated earnings. Dividend cover of 2 times and above is considered to provide a wide margin of safety for investors.
Top security
Not that earnings appear to be in any danger right now. BAE Systems’ sales rose 2.8% at constant currencies, to £10.6bn, in the six months to June. This pushed underlying earnings before interest and tax up 4.4%, to £1.1bn.
What’s more, the defence giant’s strong balance sheet should give it the means to meet dividend forecasts even if profits disappoint. It’s so cash-rich, in fact, that it launched a three-year, £1.5bn share buyback programme in July.
Why I’d buy BAE Systems shares
| BAE Systems’ share price | 804p |
| 12-month price movement | +42% |
| Market cap | £25.2bn |
| Forward price-to-earnings (P/E) ratio | 15.3 times |
| Forward dividend yield | 3.3% |
| Dividend cover | 2 times |
Defence shares are particularly vulnerable if they have problems with product failure. The expensive and critical nature of the hardware they build leave little to no wiggle room for error. Lives can be lost and the geopolitical landscape irreversibly altered. This can prove a disaster for a company’s future orders.
But encouragingly, BAE Systems has a great track record on this front. It’s why the business is the world’s seventh-biggest defence company by revenues, according to Defense News.
I’d buy the business because arms budgets look set to keep climbing for the foreseeable future. Worldwide spending rose 0.7% in 2021 and crashed through the $2trn barrier, according to the Stockholm International Peace Research Institute. And I’m expecting defence expenditure in the West to keep climbing as worries over Russian and Chinese foreign policy grow.
In this scenario, BAE Systems should enjoy strong and sustained profits growth. And this should allow it to continue delivering a healthy passive income to shareholders.
