Is the BAE share price ‘locked on’ for further returns?

The BAE share price has gone from strength to strength on the back of the Ukraine conflict. Dr James Fox explores whether there’s more to come.

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The BAE Systems (LSE:BA.) share price has seen 104% growth over the past three years. Much of this has come since Russia’s invasion of Ukraine.

So, is the defence giant set to deliver even bigger and better returns as the tragedy continues? Let’s explore.

Tangible tailwind

The share price is notably influenced by geopolitical factors. Events earlier in the summer, such as the US debt ceiling uncertainty and the Wagner mutiny, exerted downward pressure on the share price.

However, the overarching geopolitical shift is Russia’s action in Ukraine. This appears to have a real impact on the company, with half-year underlying EBIT up 10% to £1.3bn and sales up 11% to £12bn.

Additionally, the company’s order intake reached £21.1bn, resulting in a historic order backlog of £66.2bn.

It may seem obvious that the Ukraine conflict would drive demand for BAE’s high-end military equipment. But it’s interesting that Rolls-Royce has suggested there would be no immediately tangible impact on its own defence business.

It’s also worth highlighting that this increased order book doesn’t entirely reflect Ukraine’s need for more weaponry. That’s especially the case given Ukraine’s main requirements are for smaller-ticket items. These include items such as radars and ammunition.

BAE generates around 38% of revenue from its biggest sector — aviation — where big-ticket orders like aircraft have a profound impact on the size of the order book.

How long can it last?

So, even if the war ended next week — which we all hope for — BAE’s tailwind would remain.

It has a significant backlog. But we also need to highlight that governments around the world have already committed themselves to bigger military spend. And these increases have been approved by legislative bodies.

Given the ongoing tensions linked to Russia, the demand for defence capabilities is expected to remain strong.

Valuation

The BAE share price is currently at a modest discount compared to the broader industrials sector. But it largely trades in line with peers in the defence manufacturing industry.

Its price-to-earnings (P/E) ratio stands at 16.4 times on a trailing 12-month basis. This is below the industrial sector’s average of 19.6 times. This valuation puts it between Raytheon at 22 times P/E and Lockheed Martin at 15.5 times P/E.

However, when considering the EV-to-EBITDA metric, BAE appears to trade at a slight premium compared to its American peers. BAE’s ratio is 12.5 times, while Raytheon and Lockheed Martin are at 11.8 times and 11.7 times, respectively.

Fair value

Unless BAE appears vastly more exposed to the Ukraine war tailwind than its peers, it’s likely that the stock is trading around fair value.

In the current market, it’s unusual to see a UK-listed stock going head to head valuation-wise with US-listed firms.

However, while I’m guessing here, there could be more tailwinds. For example, the possible widening of the AUKUS pact, a topic I’m currently researching, could act as a further catalyst for defence innovation and production.

Japan, New Zealand, India, Canada, and South Korea are the nations interested in partnering around Pillar 2.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

James Fox has no positions in any of the share mentioned. The Motley Fool UK has recommended BAE Systems and Lockheed Martin. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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