BAE Systems (LSE: BA) shares are on a roll and they’re not alone. Another defence stock, Babcock International (LSE: BAB), is also continuing its dizzying ascent. They’re up 14.6% and 18.8% over the last month, compared to growth of just 1.18% across the FTSE 100.
Over the past year, BAE is up 50% and Babcock 143%. The driver is obvious. With Russia’s invasion of Ukraine, rising tensions in the Middle East, and concerns over China, the so-called peace dividend has gone. Western governments are scrambling to boost their defence spending and these companies are reaping the benefits.
Winning FTSE 100 sector
BAE’s Q1 results, published on 30 July, revealed “another strong half” with sales up 11% to £14.6bn and full-year guidance hiked. The order intake dipped slightly, but the backlog remains huge at £75.4bn.
Babcock’s full-year numbers, published on 25 June, were also impressive. Revenue rose 10% to £4.83bn and operating profit surged to £362.9m. The contract backlog stands at £10.4bn and the board backed a £200m share buyback with bullish talk of a “new era for defence”.
The sector also got a lift on 1 September when Norway announced £10bn for UK-built warships, with similar expected from Denmark and Sweden. That’s particularly good news for Babcock, which produces the Type-31 frigates. With hopes of a quick peace deal in Ukraine sadly fading, the order books may keep swelling.
Risks worth noting
Of course, no boom is risk-free. European governments are strapped for cash and may struggle to honour promises. Investors have also become used to giant pipelines, and even a modest slowdown could unsettle them.
Valuations are another concern. BAE trades at a price-to-earnings ratio of 28.4, while Babcock sits around 22.5. BAE’s is particularly steep, leaving little room for disappointment. Cost overruns are another hazard. Babcock has already taken a £90m provision on a Royal Navy contract, showing how complex these projects can be.
Yet the potential remains vast. BAE reckons its key markets are worth $1.75trn a year, so there’s still plenty of room to grow.
Five years of stellar gains
The long-term returns are breathtaking. Since September 2020, BAE shares have soared around 290%. That would have turned a £10,000 stake into £39,000. Babcock has done even better, up 390%, transforming the same investment into £49,000. Dividends would have added another layer of joy.
BAE’s trailing yield looks low at just 1.5%, but that’s largely due to the roaring share price with the board raising payouts by more than 5% a year on average for a decade. Babcock’s yield is slimmer at 0.5%, after cutting payouts between 2019 and 2022, but they’re climbing again. The dividend was restored at 5p in 2024, and raised 30% to 6.5p this year.
Analysts see modest growth from here, with BAE’s 12-month target at 2,115p and Babcock’s at 1,257p. That implies rises of just under 7% and 9%, respectively. Quite a dip following recent stellar returns.
After such a strong run, risks are clear. If global tensions ease as we all hope they will, these shares could lose their shine. But in today’s climate, I think investors might consider buying either of them as part of a balanced portfolio.
