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How I think clearing its pension deficit is another strong sign for the BAE share price

As investors, it is only natural that the more exciting, headline-grabbing news stories are the ones that get our attention. Stories of political strife or a new technology get the imagination fired up, but as Warren Buffett would tell you, many times it is the underlying, perhaps boring, fundamentals that can make or break an investment.

I for one, then, was excited last week when BAE Systems (LSE: BA) said it looks like it will be able to clear its pension deficit five years early, with a £1bn injection in the coming months and a further £490m this year set to more than halve the number.

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Strong foundations

As I said, some company news tends to grab headlines and some doesn’t, but for me when a company can afford to invest in this kind of non-headline-grabbing, fundamental aspect of its business, it is a far greater indication of its strength.

BAE will be borrowing the money to help pay off its pension deficit. Its forecasts for free cash flow suggest it will rise to £1bn this year, compared to £850m in 2019. BAE’s pension, which services around 180,000 members, is one of the largest in the FTSE 100, and has long overshadowed the company’s investment potential.

Though borrowing to pay off the pension will raise the company’s net debt levels to £1.8bn, by paying the deficit off early it will also end the need for top-up payments early as well – the last payment is now expected in 2021.

The one word of caution I would have is that unlike other companies such as BT, which also held a massive pension deficit, BAE hasn’t closed off its scheme to new employees. This of course leaves the pension deficit open to expanding again, though I am of the opinion that BAE will have the cash to cover it.

Income generator

For me, I have always seen BAE as a solid, safe investment that produces a nice income. In fact I agree with my Foolish colleague Alan Oscroft, that BAE is probably one of the most dependable income generators.

Due to the recent gains the shares have been making, its yield now stands at about 3.5% – not the largest number by any means but certainly towards the bottom end of what I look for, personally. Indeed I would see an intermediate price-dip as a perfect opportunity to invest in BAE to take advantage of the higher yield.

Annual growth of the dividend has also been pretty solid. Though over the last five years the annual growth rate averages just 2.2% – again solid but not exactly revolutionary – this figure actually hides the more recent growth levels.

The annual dividend was recently increased by 4.5%, and if BAE’s strength and free cash flow continue the way they have, I see no reason not to expect similar dividend growth in the next year or two. Paying down its pension deficit will only help with this goal, and makes BAE a share well worth considering.

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Karl has shares in BAE Systems. The Motley Fool UK has no position in any of the shares mentioned. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.