BAE Systems’ (LSE: BA) share price has gained 120% since Russia invaded Ukraine on 24 February 2022. It’s up over 30% in the last 12 months alone.
An increasingly dangerous world
I bought the stock while I worked as an investment banker in Russia in the early 2000s. This coincided with the rise of President Vladimir Putin.
I had no doubt that his key objective was to reconstitute the USSR’s empire in Eastern Europe. He’d said as much on 25 April 2005 when he commented that the collapse of the Soviet empire was “the greatest geopolitical catastrophe of the century”.
To me, this is a regular thematic trade, just as buying healthcare stocks on forecasts for an ageing global population.
Tensions in the Middle East look like they might escalate imminently as well. Following 1 April’s alleged Israeli missile strike on Iran’s consulate in Syria, Tehran has pledged to retaliate.
This could widen the Israel-Hamas War, and more deeply involve the US, Russia, and China too.
Countries prepare for the worst
None of us here want to see this sort of escalation. But it is a genuine threat and defence companies directly benefit from these concerns.
In just the last month, BAE Systems has seen a slew of huge new orders roll in from worried countries around the world.
On 29 March, it was awarded a $754m contract from the US Army for armoured multi-purpose vehicles. On 27 March, it won another $318m in orders for self-propelled howitzers from the US military.
And on 26 March, Japan announced it had relaxed military equipment export restrictions. This should boost the demand for jet fighters built by a consortium including BAE Systems.
At the Munich Security Conference in February, NATO member countries vowed to increase their defence spending to at least 2% of gross domestic product.
This followed US presidential hopeful Donald Trump’s comments that his administration wouldn’t protect NATO members that didn’t meet that target.
Germany’s IFO Institute has calculated that €1.8trn must be spent to compensate for 30 years of under-investment in European defence.
Business goes from strength to strength
BAE Systems’ order book rose to £58bn in 2023 from £48.9bn in 2022. Over the same period, its order backlog jumped to £69.8bn from £58.9bn.
These drove sales of £25.3bn in 2023 (from £23.3bn in 2022), and operating profit to £2.6bn (from £2.4bn). For 2024, it expects year-on-year increases in sales of 10%-12%, and underlying earnings of 11%-13%.
One risk to the stock is that the world becomes much safer, something many of us would like to see. Another is any major redesign to a core product line, which would be very costly.
However, I believe the stock will keep being powered up by new order flows.
It also benefits from looking undervalued against its peers. It currently trades on the key price-to-earnings (P/E) ratio measurement at just 21.5. This compares to a peer group average of 44.6, which looks very cheap to me.
