FTSE 100 defence giant BAE Systems (LSE: BA) failed to excite the market this week, despite issuing a solid set of half-year results.
I’m not too concerned. In my view, Wednesday’s numbers were a useful reminder of why this company has not cut its dividend for 19 years. Today I’m going to explain why I think this excellent performance should continue.
3 big advantages
In my view, this industrial group’s advantages can be boiled down to three key factors.
Size and diversity: BAE has a market cap of £20bn and five distinct operating divisions — aircraft, shipbuilding, electronics, cyber intelligence and vehicle development.
Each of these divisions is large enough to be a sizeable company in its own right. The group received £9.7bn of new orders during H1, lifting its order backlog by £1bn to £39.7bn. This is a long-term business.
Cash generation: A second attraction is that the group tends to create a lot of cash. In 2017, BAE generated free cash flow of £1.3bn from an operating profit of £1.5bn. That’s an excellent rate of cash conversion.
Although Wednesday’s figures showed a half-year cash outflow of £436m, this relates to the ramp-up of some major new projects and is fairly routine. I don’t see this as a concern.
Valuation: BAE shares are no longer priced at bargain levels. But the stock’s valuation still looks very reasonable to me.
The shares trade on 14.6 times forecast earnings, with a prospective dividend yield of 3.6%. Analysts are pencilling in earnings growth of 9% for 2019. This would put the stock on a P/E of 13.6.
A long-term buy?
I don’t expect BAE’s share price to rocket higher. Slow and steady progress seems more likely to me, helped by inflation-beating dividend growth.
I view this stock as a long-term buy-and-forget one, where all you need to do is reinvest or withdraw your dividend payment twice a year.
Could this FTSE 250 stock outperform?
If you’re looking for a business with the potential to deliver more rapid growth, there are a number of smaller rivals to BAE in the FTSE 250. One of these is aerospace and electronics group Cobham (LSE: COB).
This £3bn business is still in turnaround mode, following a series of problems a few years ago. Cobham published its half-year results on Friday, prompting a 4% rise in the group’s share price.
Unfortunately I think Friday’s gain was more of a relief rally than a celebration. Problems remain.
Boeing won’t pay Cobham’s’ bills
Cobham’s biggest problem is the KC-46 aerial refuelling tanker programme on which it’s working with Boeing. The US aviation giant is claiming “as yet unquantified damages” from Cobham relating to its work and is withholding payments of its invoices.
Regulatory approval for some parts of Cobham’s KC-46 system also seems to be taking longer than expected, and today the firm said it was allocating an extra £40m to this troubled project.
A turnaround buy?
The company says that it remains on track to deliver full-year profits in line with expectations. But in my view the risk of a profit warning later this year is rising.
Cobham could be a profitable turnaround buy. But with a 2018 forecast P/E of 26, I don’t think the shares are cheap enough to reflect the risks facing investors.
Although earnings are expected to improve in 2019, I don’t feel confident enough to bet on this.
