Flat-Lining BAE Systems plc Could Be My Next Sell

Since I purchased them in April 2012, my BAE Systems (LSE: BA) (NASDAQOTH: BAESY.US) shares have risen in value by 42%, and paid me 9.2% of my purchase price in dividends, giving a total return of 51%.

Naturally, I’m not complaining, but I am wondering whether I should continue to hold BAE Systems, or whether better returns are now available elsewhere.

Where’s the growth?

My main concern with BAE is that it appears to be stuck in a rut. Admittedly it’s a large and profitable rut, but it’s still a potential problem. City forecasts suggest that BAE’s revenue will flat-line at around £18.7bn this year and in 2014, and the firm’s sales have grown at an average annual rate of just 3% since 2007 — barely ahead of inflation.

BAE’s profits are expected to dip slightly in 2014, despite share buybacks, and while the dividend should remain safe, dividend growth is only expected to be around 3%. I don’t see any obvious reason for its share price to rise any further, despite BAE’s below-average P/E multiple of 13.9.

The problem for BAE is that there are only a limited number of countries with the means and the inclination to buy large quantities of the firm’s ships, planes and other defence products. BAE has traditionally depended on the UK and USA for most of its revenue, and while it is trying hard to diversify into new markets, it remains heavily dependent on these two countries: the US alone accounts for 40% of sales.

Better alternatives?

One alternative stock I am considering is BAE’s smaller peer, Meggitt (LSE: MGGT).

Meggitt’s share price fell by 12% in one day at the start of November, when the firm warned that a short-term production problem and contract timing issues had caused trading during the third quarter to fall below expectations.

However, I think Meggitt now looks quite good value, with a forward P/E of just 13.1, and a fairly reasonable 2.7% prospective yield. Assuming the company’s management is right, and last quarter’s disappointing trading was just a short-term problem, Meggitt could be an attractive growth buy, with the added bonus of offering exposure to both the defence market and the faster-growing civil aviation market.

Is BAE still an income buy?

I haven’t yet decided whether to pull the trigger and sell my BAE shares, as I am very attached to the generous income they provide. 

However, although I believe that BAE will remain one of the FTSE's best income stocks, it's not the company recently selected by the Motley Fool's analysts for their latest report, 'Today's Top Income Stock'.

The firm in question currently offers a BAE-beating prospective yield of 5.5%, and one of the Fool's experts believes its shares could be undervalued by 10% at present.

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> Roland owns shares in BAE Systems but does not own shares in any of the other companies mentioned in this article.