Over the past five years, shares in defence contractor BAE Systems (LSE: BA) have more than doubled the return of the broader FTSE 100, excluding dividends.
However, compared with international peers such as General Dynamics and Boeing, BAE has struggled. Indeed since 2013, shares in BAE have underperformed those of General Dynamics by 100%, excluding dividends, and Boeing by 200%.
But with defence spending on the up around the world, could BAE’s fortunes finally be about to change?
Catching up with the pack
BAE’s underperformance, compared to its international peers, is staggering. Many factors have contributed to the company’s struggles, but the primary reason is inefficiency. BAE just isn’t as efficient as its larger US peers.
For example, last year General Dynamics, which operates in reasonably similar areas to its British peer, achieve the return on capital employed — a key measure of profitability for every £1 invested — of 19%. Meanwhile, BAE’s ROCE was just 9% for 2017.
Still, despite the lack of profitability, BAE continues to pick up orders for its products from around the world. In a trading statement issued before the company’s AGM last week, the group said it had opportunities to win orders during the second half of 2018 in the US, to help build amphibious combat vehicles, and in Australia to help build warships. There’s also progress being made in negotiations with Saudi Arabia over its intention to buy 48 Typhoon fighter jets.
Based on these prospects, management believes that earnings will be “in line” with 2017 this year. This suggests a figure of 42.1p has put forward in the pre-AGM release, slightly below City forecasts.
What does the future hold?
BAE’s lack of growth is concerning. At a time when governments around the world are ramping up military spending, BAE should be capitalising on its position in the market to drive earnings and revenue growth.
Over the next two years, sales at General Dynamics are expected to grow by nearly $9bn, up 30% from 2017’s $31bn. Earnings per share are also set to rise by 30% over the same period. If BAE hits revenue growth targets, over the same period the company is projected to grow sales by 5%.
Considering the above, it’s difficult to think of BAE as a bargain. Shares in the company currently trade at a forward P/E of 13.9, which looks about right for a low-growth business. At the same time, the shares only support a dividend yield of 3.7% and this is unlikely to grow much further in the years ahead as earnings remain flat.
That being said, BAE doesn’t look to be much of a value trap either. Earnings are unlikely to fall dramatically if it continues to win contracts. And the dividend yield is well covered by earnings per share, so it’s unlikely investors will have to suffer a payout cut.
With this being the case, I am struggling to arrive at a conclusion either way for the stock. If it’s income and growth you are after, there’s certainly better buys out there, although my Foolish peer Harvey Jones seems to disagree.
