BAE Systems’ (LSE: BA) share price is down 5% from its 17 October 12-month traded high of £14.14.
I put this down to profit-taking. Shares in the defence giant have risen 120% since Russia’s 2022 invasion of Ukraine.
I believe the dip provides a rare opportunity to buy the stock at a discounted level.
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A growing order book
H1 this year saw a £1.6bn increase in BAE Systems’ order book from H2 2023, to £59.6bn. Over the same six-month period, its order backlog rose by £4.3bn, to £74.1bn.
Indeed, barely a week goes by without big new orders being announced and October was no different. It was awarded a $92m (£71m) submarine contract by the US Navy. Then it received a $184m order from the US Army for armoured multi-purpose vehicles. And mid-month, the US Army awarded it a $460m contract to upgrade its aviation fleet.
Then news came of a possible project to provide Turkey with Eurofighters. These are built by a consortium of BAE Systems, Airbus and Leonardo.
This also followed a US State Department announcement earlier this month allowing military equipment sales to Italy, India and Romania. The combined value would be $965m, with BAE Systems being the principal contractor for the Italian sales.
A risk here is that a failure in any of its major products would be expensive to remedy. It might also damage its reputation.
However, as it stands, analysts forecast that the firm’s earnings will grow by 7.3% a year to the end of 2026.
Increasing global insecurity
Tit-for-tat attacks between Israel and Iran (and its proxies) raise the prospect of a wider war in the Middle East.
Russia has eyed gradual expansion further west in Europe since it invaded Georgia in 2008. And I think it will continue to threaten other countries’ borders, regardless of events in Ukraine.
Additionally, CIA Director William Burns claimed last February that Chinese President Xi Jinping had ordered his military to be ready to invade Taiwan by 2027.
Few people want wars. However, Western leaders appear to take the view that the best way to ensure peace is to prepare for conflict.
NATO members have committed to increasing their annual defence spending to 2%+ of gross domestic product. And it has been estimated they need to spend €1.8trn (£1.5trn) to compensate for 30 years of underinvestment.
As the largest defence contractor in Europe and the seventh largest in the world, BAE Systems should benefit from this.
Are the shares undervalued?
BAE Systems presently trades on the key price-to-earnings ratio (P/E) stock valuation at just 21.6. This looks a bargain compared to the average 46.1 P/E of its competitor group.
The same applies to its price-to-sales ratio (P/S) of 1.1 against its peer group’s average of 4.4.
To ascertain how cheap it is in cash terms I ran a discounted cash flow analysis.
This shows BAE Systems’ shares to be 21% undervalued at their present price of £13.40. So a fair value for them would be £16.96, although they may go lower or higher than that.
Given this and the firm’s terrific growth prospects, I will be buying more of the shares very soon.
