Why Forecasts Were Wrong For BAE Systems

An investment in aerospace and defence engineer BAE Systems (LSE: BA) would have more than trebled in value in the past 10 years, but was that impressive track record the reason the City’s experts were too bullish a year ago?

With the Western world coming out of recession and BAE’s order book, notably its contracts with the Kingdom of Saudi Arabia, looking very healthy, analysts were forecasting earnings per share (EPS) of 42.3p for 2014.

Forecast slashed

But now, a year on, their consensus for the year to December has been slashed to 37.9p. That’s a significant change in the year-on-year picture — the earlier forecast would have produced a year of no EPS change for BAE, which wouldn’t be bad in the current economic climate.

But the latest figure indicates a 10% fall, and that’s the kind of thing that can turn investors disproportionately bearish.

On the upside, the trend in recent months has been firming up again, and the latest prediction represents a 1.4% improvement over three months, so has that had an effect on the punters?

Movements in the share price have actually been tracking the City’s sentiment quite closely. From a level of 453p a year ago, the price slipped to a 12-month low of 374p in mid-April, before picking up again to to the exact same 453p today for zero change overall — over the same time, the FTSE 100 has lost 4%, so BAE is ahead.

Part of the reason for the downgrade must be due to the pricing terms of BAE’s Salam Typhoon contract with Saudi Arabia — the arrangement of prices and installments meant a drop in EPS this year, and the effect wasn’t known for sure until 2013 results were published in February. But according to the company the impact was going to be around 5%, accounting for only half the cut in forecasts.

Poised to beat expectations?

Then at the halfway stage BAE told is to expect a fall in EPS of 5-10%, partly due to exchange rate effects and based on a $1.70 exchange rate.

Since then the pound has dropped to $1.59, so my feeling is that the current forecast is too pessimistic and I can see BAE doing better in EPS terms this year than the current consensus suggests.

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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.