BAE Systems (LSE: BA.) shares have tripled since 2020 and a lot more growth might be on the way.
Defence spending is surging. The global amount spent broke a new record last year as a perhaps complacent Europe realises more needs to be done protecting its borders.
After his country spent 2% of GDP for the first time this year, the German defence minister declared it just the “starting point” for NATO countries. He spoke of 3% or 3.5% by the end of the decade.
Historical turning point
His chancellor called the Russian invasion of Ukraine a “historical turning point” and it’s hard to disagree.
It’s undoubtedly a sad state of affairs – and I wouldn’t blame anyone for not wanting to invest – but the sad reality is defence companies could end up being the best investments in coming years.
FTSE 100 member BAE Systems is the largest of these firms in the UK with a £37bn market value.
The defence giant has already seen the impact of the global conflicts with a £10bn rise in spending since June, which created 5,000 jobs. The firm upgraded its guidance too.
Part of the rise was an “unprecedented” number of contracts from the UK government – one of the biggest defence spenders across the globe and the biggest in Europe.
BAE has a number of contracts with the US too – a country that makes up about a third of all military spending worldwide.
Cat out of the bag
What I believe will keep BAE’s order book strong for the long term is its state-of-the-art engineering. For example, the firm plays a key role in the development of the AUKUS nuclear-powered submarine programme between the UK, the US, and Australia.
Moreover, BAE just agreed a deal to supply M777 Howitzer parts to the US after the weapon performed admirably in the defence of Ukraine.
In an ideal world, that conflict and the various others around the globe will end as soon as possible. In that event, you might think it would be bad news for the BAE order book.
But the cat is out of the bag now. With leaders like Putin in the world, I suspect governments aren’t going to relax when allocating funds to defend themselves.
My move
As far as risks go, BAE has developed a habit of completing projects on time and over budget. This could be problematic if it leads to fewer orders moving forward.
As for valuation, BAE trades at around 20 times earnings. That’s almost double the FTSE 100 average although a little less than the UK Defence industry average of 24.7.
I’d have to say that looks dirt-cheap. I do own the shares already but will consider topping up my position soon.
