The BAE Systems (LSE:BA.) share price has been the eighth-best performer on the FTSE 100 over the past five years. Those investing £10,000 in September 2020 will now (at close of business on 9 September) be sitting on a profit of £25,276. They will also have picked up some reasonable dividends (152.6p a share) along the way. This means their overall gain is £28,279.
A question of conscience
But it’s a sad reality that much of this paper profit was recorded after Russia invaded Ukraine. Understandably, this doesn’t sit comfortably with everyone.
Personally, I believe there’s nothing wrong with making money out of a company that’s helping a country defend itself. After all, BAE Systems is the Ministry of Defence’s largest contractor and one of the 10 biggest suppliers to the US Department of Defense.
However, I have to admit that President Trump’s recent decision to change the name of the latter to the War Department undermines my argument a little. Nonetheless, as long as a company’s engaged in legal activity and pays its taxes, I think it’s okay to consider investing.
Missing the boat
A look at the 12-month price forecasts of analysts suggests that the rally isn’t over yet. They have an average (median) target of £21.64. This is 20.8% higher than today’s price.
I’m sure some of this optimism was helped by the group’s results for the six months ended 30 June (H1 25). Compared to H1 24, sales were up 11% and underlying earnings per share increased 12%. It also upgraded its revenue and profit forecasts.
Surprisingly, the group also reported a £2.4bn drop in its order book during the period. Having said that, it still stands at £75.4bn, which is larger than the UK’s annual defence budget.
Some challenges
One concern I have is that the group suffered a £587m swing in its free cash flow. For H1 24, it saw an inflow of £219m. During H1 25, there was an outflow of £368m. The company puts the decline down to a timing issue rather than an indicator of anything fundamentally wrong.
And its shares aren’t cheap. Based on a current price of £17.92, the stock trades on a multiple of 26 times its historic (2024) earnings. Using current forecasts, this drops to 23.6 (2025) and 21.1 (2026). Admittedly, this isn’t in bargain territory but it’s likely to be a bit more attractive to value investors when it’s considered alongside the forecast 2025 Rolls-Royce price-to-earnings ratio of 43.6.
Final thoughts
But I remain optimistic that the group can support an above-average valuation through strong growth.
It says its key markets are worth $1.75trn a year so there’s plenty more revenue to go after. NATO members have committed to increasing core military spending to 3.5% of Gross Domestic Product by 2035. Being an industry leader in a growing market is likely to be lucrative.
To give further earnings protection, the group covers all aspects of defence – land, sea and air – which puts it in a strong position when looking for new customers. It undertakes multi-decade programmes (secured by long-term contracts) that aren’t affected by the ups and downs of the normal economic cycle.
The stock’s also yielding a solid — if unspectacular — 1.9%. For these reasons, BAE Systems could be one to consider.
