Barely a month goes by without big new orders being announced that fundamentally support BAE Systems’ (LSE: BA.) share price, in my view.
September was no different. On the 26th it received a $177.8m contract from the US Navy to maintain and modernise its destroyer USS Halsey.
The 13th saw the UK’s Ministry of Defence awarded it a £60m contract to upgrade the Royal Navy’s Sting Ray lightweight torpedo.
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And the US Army finalised a $440m contract with it on the 12th to produce additional Bradley fighting vehicles.
Before this, H1 saw a £1.6bn increase in its order book from H2 2023, to £59.6bn. Its order backlog jumped £4.3bn over the same six-month period, to £74.1bn. These increases drove its sales 13% higher, to £13.4bn.
What’s the defence sector outlook?
None of these numbers surprise me. BAE Systems is the largest defence contractor in Europe and the seventh-largest in the world. And sadly, I think the world’s security situation has not looked so perilous for decades.
The stock dropped from 17 September on rumours that Ukraine’s allies are talking about a negotiated ceasefire. This would be terrific news for all of us, depending on the terms.
However, even if true, it would not decrease the ongoing threat to Europe from Russia, in my view – or NATO’s either, it seems. Its members have committed to increase their annual defence spending to 2%+ of gross domestic product.
Nor would it reduce the potential for an escalation of conflict in the Middle East given Israel’s latest advance into Lebanon. And it would not diminish the potential for major superpower conflict in Asia, centred around Taiwan.
How does the firm’s growth look from here?
In its H1 2024 results, BAE increased its sales guidance by 2% for this year — to 12%-14% (from 10%-12%). It boosted its earnings before interest and taxes projection by 1% — to 12%-14% (from 11%-13%).
And it raised its free cash forecasts by £200m – to over £1.5bn. This would give a total free cash flow delivered in the three years to end-2024 of over £6.0bn. This itself can be a major driver for growth.
Earnings predictions are subject to risk, of course, and in BAE Systems’ case, one is any failure in one of its products. This could prove very costly to remedy and could negatively affect its reputation.
That said, as it stands, analysts forecast that its earnings will grow by 7.3% each year to the end of 2026.
Are the shares cheap?
I already own the stock from much lower price levels, so I am happy with that position.
However, if I did not have it, I would see them as an unmissable buying opportunity at the current bargain price.
On the key price-to-earnings (P/E) measure of stock value, BAE Systems trades at just 20.2. This is cheap against the average P/E of its competitor group of 44.4.
In fact, a discounted cash flow analysis shows the shares to be 25% undervalued at £12.29. So I believe a fair value would be £16.39.
They may go higher or lower than that, given the vagaries of the market. But it underlines to me how much of a bargain they look right now.
