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Why BAE Systems plc Should Be A Winner This Year

BAE Systems (LSE: BA) (NASDAQOTH: BAESY.US) gets my attention today, in my examination of the prospects for some of our top FTSE 100 companies in 2014.

Let’s start with a look at BAE’s performance over the past five years, with the latest consensus forecasts for this year and next:

Dec Pre-tax EPS Change Dividend Change Yield Cover
2008 £2,371m 37.1p +23% 14.5p   3.8% 2.6x
2009 £266m 40.1p +8% 16.0p +10% 4.5% 2.5x
2010 £1,409m 39.8p -1% 17.5p +9% 5.3% 2.3x
2011 £1,466m 45.6p +15% 18.8p +7% 6.6% 2.4x
2012 £1,369m 38.9p -15% 19.5p +4% 5.8% 2.0x
2013(f) £1,371m 42.7p +10% 20.3p +4% 4.6% 2.1x
2014(f) £1,348m 42.0p -2% 20.9p +3% 4.8% 2.0x

An erratic few years

We see a bit of a crunch in 2009, but with payments for major contracts being irregular in the aerospace and defence business, profits on a year-by-year can be volatile. And by maintaining strong cover, BAE has been able to keep its dividends going nicely ahead of the FTSE’s average of around 3%.

Those 2013 forecasts were looking reasonably safe at the time of BAE’s third-quarter update in October, which told us that “Trading for the period has been consistent with management expectations at the time of the half-year results announcement on 1 August and the outlook remains unchanged“.

But since then, a hoped-for deal with the United Arab Emirates has fallen through, and a failure to agree pricing for a Typhoon contract with Saudi Arabia is set to knock 6-7p off EPS. So instead of that forecast 10% rise in EPS, we could be seeing a small fall instead.

But it’s really more of a delay than a loss, and I can’t see any long-term harm coming from it.

The share price

The BAE share price has performed poorly over the last five years, gaining only around 10% while the FTSE 100 has put on 45%. But over the past year, the picture is looking a bit better, with BAE shares up 22% compared to 12% for the FTSE.

But even after the gains of the past 12 months, BAE shares are still on a forward P/E based on 2014 forecasts of only 10, which is quite a bit below the FTSE average of around 14. Cheap? I think so.

At the end of 2011, when the shares were around their bottom, BAE’s P/E stood at an almost unbelievably low 6.3 even though that dividend stream was still flowing strong. Do you wish you’d bought some then? I wasn’t running the Fool’s Beginners’ Portfolio at the time, but I did add BAE Systems to it on October 2012 at a price of 332p — and we’ve seen a 30% gain since then.

Further to go?

At current valuations, I really can’t see BAE having anything but a positive 2014, and I’d be very surprised not to see that P/E strengthening over the year with a decent share price rise.

Verdict: Climbing higher in 2014

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> Alan does not own shares in Royal Dutch Shell or BP.