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How I’d use defence bargains as the best form of attack against FTSE 100 falls

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Looking beyond the short-term falls of the FTSE 100, the long-term prospects for defence giant BAE Systems (LSE: BAE) are excellent. This stock currently trades at a 25% discount to its year high, and looks like a bargain to me.

Positive long-term outlook

The FTSE 100 defence giant is renowned for producing heavy military equipment, including fighter jets and aircraft carriers. Contracts to provide this equipment are enormous in value and long in duration. This is excellent for investors as it provides long-term visibility of future revenues and profits. The forward order book for BAE is plentiful and varied, which provides the company with a buffer from any short-term issues.

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Financials  

BAE reported that sales had increased by 7% to £20 billion and operating profit had increased by 5% to £2.1 billion in its full year results. It is a popular income share and has cautiously deferred its final dividend payment. If delivered, the stock will yield 5%, well above the FTSE 100 average.

Why has the share price fallen?

Investors will be concerned that government’s investment in defence will be under review and spending cuts will be implemented. However, due to the current number of simmering global tensions and an increase in civil unrest, I don’t think current spending levels will fall.

Optimising cash flow is a priority for BAE as it nears the completion of two strategic acquisitions for future growth. However, the company has access to an enormous credit facility. So personally, I don’t see how cash flow should impact the share price.

I believe the share price fall is a classic example of how a price can follow the performance of the wider FTSE 100, rather than move in relation to the performance of the business. Benjamin Graham, the man who inspired Warren Buffett, eloquently describes this as follows: “In the short run, the market is a voting machine but in the long run, it is a weighing machine.”  I consider BAE to be a bargain and once it has been “re-weighed”, the share price should soar.

The rise and rise of cybercrime

These days, the defence industry is more diverse than just heavy military equipment. As more aspects of our lives move online, the risk of being a victim to cybercrime significantly increases. It is estimated damages relating to cybercrime have doubled since 2015 to $6 trillion. It is therefore easy to understand why domestic and corporate spending on cybersecurity has exploded.

Avast will be the first company specialising in cybersecurity to be promoted to the FTSE 100 on 22nd June. It is one of the largest cybersecurity companies in the world, and has 12.62m paying customers and several established long-term partnerships.

Revenues are currently $870m and will continue to grow strongly, but more importantly operating profit is an impressive 39%. Its dividend yield is currently below the FTSE 100 average at 2.4%. However, these payments are forecast to grow in the future. Rising revenues, profits and dividends in a growing industry makes this share another defence bargain in my opinion.

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Ben Race owns 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.

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