BAE Systems (LSE: BA) (NASDAQOTH: BAESY.US) has been in the wars recently — cuts to the US defence budget saw its profits fall from £959m in 2012 to £176m in 2013, but a solid set of half-year results and an attractive outlook means that I think now is the time to buy!
Conditions for a return to growth
Management have warned that flat US defence spend will continue to place pressure on BAE’s order book. The US Army is in the process of phasing 450,000 soldiers out of its rosters, and by the time it finishes it will be at its smallest since before World War 2!
I cannot see this situation continuing for long; the federal deficit fell from 10% of GDP in 2009 to 4% this year and, if history is anything to go by, the US will eventually revert to higher defence spending. Indeed, an increased defence spend featured as a cornerstone in The Republican’s most recent budget proposal. The Republican budget had little chance of being passed in a Democratic-controlled senate, but if they should return to the White House then their motto of ‘peace through strength’ is sure to contribute to BAE’s recovery.
Furthermore, conflicts in the Ukraine, Gaza, Syria and Iraq will accelerate defence spend as the UK and US demand that NATO members increase military investment to defend these politically unstable regions.
Looking further into the future, emerging economies will build professional and well-equipped armed forces to manage the ever-changing and increasingly complicated demands of modern security. Indonesia, for example, has more than doubled its defence spend in the past five years, while China has increased its spend at a compounded annual growth rate of 10% over the past 10 years.
BAE Systems has set its sights on these future drivers of growth. It has recently announced a contract with the Royal Saudi Airforce worth $1.3bn, on top of pre-existing contracts with both the Royal Saudi air and naval forces worth $6.4bn.
Diversified Defense
In an age where sensitive data can be stolen from the other side of the world, governments can no longer defend their borders with troops and tanks alone, and even private companies require outsourced security to protect against online crime.
The 2013 Sony PlayStation hacking resulted in the theft of 12.3 million user’s credit card details. Sony’s brand was irrevocably marred, with many gamers afraid to trust their card details to Sony’s online store again (myself included!)
BAE Systems’ Applied Intelligence division works alongside clients to prevent these costly attacks, and is an encouraging sign of the management’s ability to remain relevant through innovation in an ever-evolving industry.
It is estimated that worldwide cybercrime, such as unauthorised trading, healthcare fraud and card fraud, has an annual cost of $1 trillion.
It will soon be the norm for governments and companies to spend massive amounts of money preventing cyber crime, and BAE are well positioned to take a big slice of growth in this exciting sector.
BAE Systems’ long-term outlook is positive, but investors will not be left empty handed while they wait for it to arrive…
A dividend that shoots the lights out!
BAE has increased its dividend every year since 1999, and this year looks to be no different. BAE increased its interim dividend by 2% resulting in a market-beating yield of 4.47% for 2014. The dividend is covered 1.8 times by earnings, leaving plenty of room for increases even if earnings growth does not materialise in the short term.
Whilst it is true that BAE Systems has suffered in recent years, this bluest of blue-chip dividends payer is certainly being overlooked by the market at current, with the shares trading hands at an undemanding price to earnings ratio of 12.1! With the FTSE trading at a PE of nearly 14, I believe BAE Systems comes with built-in damage limitation. I’m more than happy to receive an incredible dividend yield while I wait for this truly global defence giant to recover.
