The BAE Systems (LSE: BA) share price has been on a tear this year, up an incredible 46% year-to-date. This is in total contrast to the overall FTSE 100, which is down 8% over the same period. One share of BAE is now trading for 809p, compared to just 550p at the turn of the year.
So, what’s going on here, and is it still worth me buying shares at this elevated price?
Is a ‘new Cold War’ brewing?
Last year at the United Nations, President Joe Biden said that the US does “not seek another Cold War”, and was not “asking any nation to choose between the United States or any other partner.”
In reality, though, most foreign policy experts believe that with the US on one side, and Russia and China on the other, a ‘new Cold War’ may have already started.
In response to Russia invading Ukraine in February, nearly all major nations around the world have been bolstering their defence systems. For example, Germany has declared a rise in its defence spending from 1.5% to 2.% of GDP, which equates to around £83bn.
The UK has committed to significantly increasing its military for the first time since the end of the original Cold War. Assuming no change of heart, defence spending will double from its current level to hit £100bn in 2030. I think this increase is unlikely to be reversed, no matter which leader is in Downing Street.
How does BAE Systems benefit?
In its 2022 half year results, BAE management said: “We see further opportunities to enhance the medium and long-term outlook as our customers commit to increased defence spending to address the elevated threat environment.”
As one of the largest defence contractors in the world, any such backdrop is obviously good news for the firm. And this can already be seen in the results. Sales increased by 2.8% on a constant currency basis to £10.6bn, but the backlog of orders rose an impressive 18% to £52.7bn.
Even after its meteoric rise, the stock has a price-to-earnings (P/E) ratio of 18, which doesn’t seem extraordinarily high to me. It also pays a dividend, with a yield around 3.1%.
Risks in the stock price
One risk I see with BAE Systems is the amount of debt on its balance sheet. As of 30 June, its net debt, excluding lease liabilities, increased to £3.1bn. In the current environment of rising interest rates, servicing this debt could get more expensive.
The biggest risk to the share price, though, is the hoped-for end to the war in Ukraine. The stock jumped in February at the outset of the war and has risen since.
As a potential investor, this last point would leave me in a strange position. I want the war to end, while knowing this would probably hurt the company’s share price. I don’t tend to root for situations that would immediately bring down the value of my investments, so I won’t be buying the shares.
Having said that, I think the heightened global tensions between the US and China will underpin healthy growth for BAE Systems over the medium-to-long term. The US remains its largest customer (at 43% of sales) and I don’t see Uncle Sam reducing defence spending in today’s geopolitical environment.
