Should I Invest In BAE Systems Plc?

To me, capital growth and dividend income are equally important. Together, they provide the total return from any share investment and, as you might expect, my aim is to invest in companies that can beat the total return delivered by the wider market.

To put that aim into perspective, the FTSE 100 has provided investors with a total return of around 3% per annum since January 2008.

Quality and value

If my investments are to outperform, I need to back companies that score well on several quality indicators and buy at prices that offer decent value.

So this series aims to identify appealing FTSE 100 investment opportunities and today I’m looking at BAE Systems (LSE: BA) (NASDAQOTH: BAESY.US), which describes itself as a defence, aerospace and security company.

With the shares at 389p, BAE Systems’ market cap. is £12,588 million.

This table summarises the firm’s recent financial record:

Year to December 2008 2009 2010 2011 2012
Revenue (£m) 16,671 20,374 20,980 17,770 16,620
Net cash from operations (£m) (1,095) 1,630 962 482 2,173
Adjusted earnings per share 37.1p 40.1p 39.8p 45.6p 38.9p
Dividend per share 14.5p 16p 17.5p 18.8p 19.5p

Thanks to continuing pressure on government defence budgets in the company’s biggest markets, the UK and the US, the directors at BAE Systems are expecting muted growth in underlying earnings during 2013. Despite such challenges, the firm made good progress with cash flow and debt-reduction during 2012, which is reassuring for those placing their faith in the dividend, and there’s an attractive-looking 5.3% or so forward yield at the current share-price level.

The firm supplies many of the world’s fighter planes, radar, attack missiles, warships and munitions, and has ambitions to become the world’s leading defence, aerospace and security company. In today’s global environment, it’s difficult to see the firm’s offering going out of fashion, although it’s clear that national defence budgets fluctuate according to macro-economic conditions. I don’t think BAE Systems is likely to shoot the lights out on earnings-growth, but the constant nature of the business makes me optimistic about the dividend’s ability to contribute steadily towards total investor returns.

BAE Systems’ total-return potential

Let’s examine five indicators to help judge the quality of the company’s total-return potential:

1. Dividend cover: adjusted earnings covered last year’s dividend almost twice. 3/5

2. Borrowings: at the last count, there was net cash on the balance sheet.  5/5

3. Growth: cash flow strongly supports recently declining revenue and earnings.  2/5

4. Price to earnings: a forward 9.2 looks ahead of current growth and yield expectations.  2/5

5. Outlook: satisfactory recent trading and a cautiously optimistic outlook. 3/5

Overall, I score BAE Systems 15 out of 25, which makes me cautious about firm’s potential to outperform the wider market’s total return, going forward.

Foolish Summary

Although earnings and revenue declined during 2012, the firm performed well on cash generation, which underpinned the dividend and boosted the balance sheet. The valuation seems full compared to growth expectations. I’m keeping the firm on my watch list for the time being.

But that steady dividend has caught the eye of at least one well-known, out-performing investor. BAE Systems is one of 8 Income Plays Held By Britain’s Super Investor. This report analyses the £20 billion portfolio of legendary high-yield expert Neil Woodford and is free for a limited time. To discover the other seven of his favourite dividend growth selections, click here

> Kevin does not own shares in BAE Systems.