BAE Systems‘ (LSE: BA.) share price has fallen 14% from its 12 November one-year traded high of £14.15.
This followed the release of its Q3 trading statement, although this had less to do with what was in it than with a pause taken for profit-taking, I think.
After all, the stock has risen 20% so far this year. And it is up 104% from its opening price on the morning of 24 February 2022 when Russia invaded Ukraine.
What was in the trading statement?
The defence giant affirmed its positive financial performance guidance for full-year 2024 given in its 1 August H1 results.
Specifically at that point it raised its year-on-year sales growth estimate to 12%-14% by end-2024 from the previous 10%-12%. It increased its forecast underlying earnings before interest and taxes growth to 12%-14% from 11%-13%. And it boosted its underlying earnings per share growth projection to 7%-9% from the earlier 6%-8%.
The firm also boosted its free cash flow target to over £1.5bn from over £1.3bn.
Several major new deals in Q3 were highlighted, including €2.5bn from BAE Systems’ share in the MBDA operation. This is a joint venture between the UK firm, plus Airbus and Leonardo to design and produce missiles and missile systems.
Since the statement, the firm was awarded a $202m US Navy contract and a follow-on US Army contract for an unspecified amount.
Are the shares undervalued?
A principal risk to the shares in my view is any major failure in one of the firm’s core products. This would be costly in monetary terms and could damage its reputation too.
However, as it stands, the stock looks very undervalued to me on several key measures I use. On the price-to-earnings ratio (P/E), BAE Systems currently trades at just 20 against an average 35.2 for its competitor group. So it looks cheap on this basis.
The same applies to its price-to-sales ratio (P/S) of 1.5 against its peer group’s average of 3.9.
To translate these undervaluations into share price terms, I ran a discounted cash flow analysis. Using other analysts’ figures and my own, this shows BAE Systems’ shares are 23% undervalued at their present price of £12.21.
Therefore, a fair value for the stock is £15.86, although they may go lower or higher, given market unpredictability.
Will I add to my holding?
BAE Systems is one of the very few companies with a low yield that I retained after I turned 50. In 2023, it paid a dividend of 30p, which yields 2.5% now.
Most of my other shares provide me with yields of well over 7%. I aim to maximise the income these stocks generate to increasingly reduce my working commitments.
That said, I have added to my holding in the defence firm over the years because of its high growth prospects in my view. These are ultimately what drive a company’s share price (and dividend) higher over time.
This investment rationale still looks firmly in place to me with BAE Systems. Hence, I will be buying more of the shares very soon.
