BAE Systems (LSE: BA.) provided a bullish trading update this week. The defence firm said that higher military spending is resulting in an exceptionally strong intake of orders. Should I finally add BAE shares to my portfolio on the back of this news.
What happened?
“[We expect] another year of top line growth and margin expansion in 2023. We see sales growth coming from all sectors and opportunities to further enhance the medium-term outlook as our customers address the elevated threat environment.”
Charles Woodburn, Chief Executive, BAE Systems
This strong order intake has resulted in £18bn for the first half of the year, and now a further £10bn in the second half.
The firm also announced this week that it has been awarded a £4.2bn contract from the UK’s Ministry of Defence. This is to manufacture the next batch of five Type 26 frigates for the Royal Navy. The Type 26 warship is designed for anti-submarine warfare and high-intensity air defence.
BAE generates a significant portion of its earnings in dollars, so is currently benefiting from the strong US currency. The company is still guiding for underlying earnings per share growth of 4%-6% for the year, on a constant currency basis.
Geopolitical tensions
BAE Systems stock rose dramatically when Russia invaded Ukraine in February. This invasion has ratcheted up geopolitical tensions to levels not seen since the days of the Cold War. And the China-Taiwan situation adds to the global tensions.
This backdrop is the “elevated threat environment” that BAE management is referring to. And unfortunately, I think this geopolitical environment is unlikely to change anytime soon. In the wake of the war in Ukraine, I think BAE Systems – as Europe’s largest defence firm – is poised to grow for many years.
Should I buy the stock?
BAE shares are often put into the so-called ‘sin stock’ category, along with gambling, tobacco and other such stocks. I myself don’t think defence is a vice, like smoking or having a quick flutter. It’s a sad but absolute necessity in the modern world, and always will be.
The stock has been one of the best performers on the Footsie this year, up 36%. However, over a five-year period, the performance hasn’t been as impressive, with it rising just 41%.
Even after its rise this year, the stock still looks good value for me. It has a price-to-earnings (P/E) ratio of 17, which doesn’t seem excessive given the firm’s growth prospects.
And the stock pays income, with a respectable dividend yield of 3.3%. The dividend has been grown over many years, and is likely to continue growing. Plus, it has a £1.5bn three-year share buyback programme in place, which it’s roughly a third of the way through.
All in all, I think this defence stock looks a buy to me today. Regardless of how much the UK raises its own military budget (or not), international demand for defence will remain robust.
I’ll be adding BAE shares to my portfolio this month.
