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Why BAE Systems plc Should Beat The FTSE 100 This Year

BAe SystemsBAE Systems (LSE: BA) (NASDAQOTH: BAESY.US) shares didn’t start the year too well. Continuing a slide that started towards the end of 2013, the price dipped as low as as 374p in April.

But since then we’ve seen a steady climb, and at 457p today BAE shares are up 5.1% on the year so far, while the FTSE 100 has actually fallen almost 3%. And BAE is up 22% since that April low, so if you’d been lucky with the timing you could be doing nicely.

Strong second half

But what’s brought about the change in sentiment?

Part of it is the nature of long-term defence contracts, which can lead to short-term year-on-year volatility in earnings. In this case, the timing of payments on the company’s Salam Typhoon contract with Saudi Arabia favoured the second half of last year.

The strength of sterling was also having an effect in expectations at the halfway stage, as the pound soared above $1.70 and adversely affected business priced in dollars.

At the time of its first-half results, BAE said “the Group continues to expect reported earnings per share to be some 5% to 10% lower than in 2013“, pinning the reason on these two causes.

But since then, the pound has reversed its gains against the US dollar, and it’s now back down to around $1.62 — which is almost exactly the same as it was a year ago.

There was most likely a bit of profit-taking too in the early part of the year, after a very strong overall price rise since 2011, and with BAE’s long-term prospects (including an order book worth around $40bn), investors have started to come back.

How’s the outlook?

Despite a fall in EPS forecast for the year, BAE shares are on a forward P/E of a modest 12.4 and there’s a dividend yield of 4.3% expected — and 2015 forecasts should shift those each in the right direction, to 11.9 and 4.4% respectively.

We might even see a reduction in this year’s expected EPS fall once recent exchange rate changes filter through into forecasts, although the firm’s third-quarter update was a little mixed. Order intake is still looking good, but we heard that “some limited trading disruption is likely in the last quarter” due to restrained US government spending.

On the whole, 2014 looks like being another good year for BAE Systems, and there’s surely more to come as defence spending restrictions start to loosen, especially in the US.

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Alan Oscroft 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.