BAE Systems (LSE: BAE) (NASDAQOTH: BAESY.US) is a company I’ve liked for some time.
I added it to the Fool’s Beginners’ Portfolio in October 2012 at 332p and today the price is up 38% to 457p, and we have another 11% to add to that in dividends — not a bad return in just under two years.
At the time I thought BAE and the aerospace and defence sector were just too cheap. Government spending had been cut severely and profits were being squeezed as a result, but such things are short term and it’s an industry with tremendous long-term potential.
Still cheap?
Looking again today, I still think BAE Systems shares are undervalued.
The lengthy nature of contracts tends to mean that paydays can be erratic, so on a year-by-year basis earnings per share (EPS) can be volatile. But BAE is holding up pretty well under current market pressures, and by 2015 annual EPS should be largely flat over a period of five years based on the latest consensus.
That would put the shares on a P/E of around 12, which is below the FTSE 100‘s long-term average of 14.
I think that would be a fair valuation if the hard times were still with us. But at the halfway stage this year, chief executive Ian King was moved to say that BAE “continues to perform well, benefiting from good programme performance on its large order backlog of almost £40bn“. That’s a lot of future work already lined up, and the safety margin of a lower-than-average P/E just doesn’t seem to be needed.
Cash cow
If undervaluation isn’t a good enough reason to buy, how about very dividend yields?
BAE’s dividend has been steadily growing, and even though the share price has stormed ahead over the past few years, analysts are still expecting a 4.4% yield this year — easily better than the FTSE’s average of around 3%. Actually, if you’d bought some shares back when they were seriously depressed in 2011, you’d have had a yield of 6.6% that year followed by 5.8% in 2012!
But even though those days are behind us, future dividends should be about 1.9 times covered and still look very desirable.
Worldwide sales
If this isn’t enough already, the clincher for me is the thing that cushioned BAE from the fall in UK and US defence spending, and that’s a key international presence — Mr King spoke of the firm’s “high level of activity in international markets“, pointing to its “substantial presence in the Kingdom of Saudi Arabia“.
Saudi Arabia is a big spender in the defence sector, and BAE’s relationship with the kingdom is a strong one — its ongoing contract for the supply of Typhoon fighters is one of its most important deals.
Calming the waters
The US and UK did provide 60% of BAE’s turnover in 2013, but the 20% from Saudi Arabia made a big difference while the other two were economizing.
