BAE Systems’ (LSE: BA) share price has dropped 10% since its 3 June 12-month traded high of £13.99.
Part of this may be due to profit-taking by some investors after a long run-up in price. It has more than doubled since Russia invaded Ukraine on 24 February 2022. So, it does not indicate the beginning of a genuine bearish trend, in my view.
Another issue might be the 25 June profit warning from Airbus and reduction in its delivery schedule for this year. BAE Systems works alongside Airbus and Italy’s Leonardo in the Eurofighter consortium.
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However, 8 July saw Italy’s Ministry of Defence announce it will spend €7.5bn on 24 new Eurofighters over the next 11 years.
The defence sector outlook
Even if the Russia-Ukraine and Israel-Hamas wars ended soon, which is what every sensible person hopes for, ongoing increases in defence spending have still been agreed.
NATO members have committed to increasing theirs to 2%+ of gross domestic product (GDP) each year. Germany’s IFO Institute calculated that €1.8trn must be spent to compensate for 30 years of underinvestment.
April saw the UK vow to spend at least 2.5% of its GDP each year on defence by 2030. The newly-elected Labour government has said that it aims to reach this target “as soon as resources allow”.
Moreover, the security threat remains high between North and South Korea, and between China and Taiwan.
How does the company look?
A risk to the firm is that the world becomes a much safer place soon, as we all want. This might decrease the acceleration in military spending over time. Another is any major redesign of a core product line, which would be very costly.
However, BAE Systems’ order backlog leapt to £69.8bn in 2023 from £58.9bn the previous year. Over the same period, its order book rose to £58bn from £48.9bn.
Its operating profit increased 8% in 2023 – to £2.573bn (from £2.384bn) – as sales jumped from £23.3bn to £25.3bn.
On 9 May, it said it is on track to achieve 6%-8% earnings per share growth this year on revenues 10%-12% higher.
Are the shares undervalued?
Despite the big rise in price since 2022, the shares trade at a price-to-earnings ratio (P/E) of 20.6. This is very cheap against the average P/E of its peers of 41.3.
The same is true of the key price-to-book (P/B) ratio. BAE Systems trades at a P/B of just 3.6, against a peer group average of 4.5.
There is no guarantee that the shares will rise from here, of course. But these key measurements underline to me that they still have a lot of value left in them.
Will I buy more now?
I bought shares in the firm at a much lower price some years ago and am happy with that position so will not be buying more as that could unbalance my portfolio. However, if I did not have that holding I would buy BAE Systems now for three key reasons.
I think the defence sector will grow robustly, with the firm ideally positioned to benefit.
Second, the 10% dip in share price is a rare opportunity to buy a share I believe was already undervalued.
And third, I think the dividend will increase from the current modest 2.4% as earnings and profits grow over time.
