1 Reason I Wouldn’t Buy BAE Systems plc Today

Today I am looking at why BAE Systems’ (LSE: BA) (NASDAQOTH: BAESY.US) terrific dividend record could be in jeopardy.

Dividend growth under pressure?

For investors seeking access to bubbly income growth, defence giant BAE Systems has long been a particularly lucrative stock selection. Even though heavy restrictions on Western defence budgets and lumpy contract timings have caused earnings to oscillate during the past five years, the firm’s huge cash reserves have enabled it to keep dividends rumbling higher during this period.

The arms giant has lifted the full-year payout at a compound annual growth rate of 6% since 2009, and City analysts expect the firm to baemaintain this upward trend during the medium term at least. Indeed, a 1.5% rise is chalked in for the current year to 20.4p per share, and an extra 2.5% rise is anticipated for 2015 to 20.9p.

These projections create mighty yields of 4.6% and 4.7% respectively, smashing a forward average of 3.2% for the FTSE 100. Still, the sizeable momentum slowdown expected this year and next is indicative of the heavy financial pressure which could affect future payment rates.

Firstly, predicted earnings of 37.2p per share for 2014 and 38.8p for 2015 mean that expected dividends are covered 1.8 times and 1.9 times by earnings for these years. These figures are hardly calamitous, even if they do fall below the widely-regarded security yardstick of 2 times.

But with debt levels also creeping up — net debt clocked in at £1.18bn as of the end of June versus £699m at the close of 2013 — BAE Systems may struggle to meet even these modest dividend growth forecasts. With the company describing activity in its key US and UK markets as ‘constrained‘ in July’s interims, there is clearly little wiggle room should earnings disappoint.

The company’s terrific performance in non-Western markets such as Saudi Arabia, India and Australia has boosted confidence in strong earnings and dividend growth in coming years. Indeed, the business clocked up another £9.3bn worth of orders from non-US and UK markets last year alone.

Still, should the effect of macroeconomic cooling in developing regions have a similar effect on defence budgets as those in the West, and budgetary pressure across its traditional customer base in the West drags on, BAE Systems’ splendid payout growth of yesteryear could be consigned to history.

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Royston Wild has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.