How I Rate BAE Systems plc As A ‘Buy And Forget’ Share

Right now I’m analysing some of the most popular companies in the FTSE 100 to establish if they are attractive long-term buy and forget investments.

Today I’m looking at BAE Systems (LSE: BA) (NASDAQOTH: BAESY.US)

What is the sustainable competitive advantage?

BAE produces everything from small arms munitions to submarines and is the most diversified weapons producer in the world.

Having said that, this has recently put the company at somewhat of a disadvantage. Indeed, unlike peers Lockheed Martin, Boeing and Raytheon, which have been able to offset falling arms revenue with expansion into the civil aviation and space markets, BAE has not been able to switch its customer base so quickly.

Still, the global arms market is dominated by only a few companies and BAE is one of them, so customers are drawn towards BAE’s experience.

Moreover, due to the fact that BAE’s products are highly specialist and for the most part, cannot be built by any other company, the firm can set its own prices and maintain a suitable profit margin.

This also means that there is less competition from peers as each company is generally a specialist in its own field and has certain customers with specific needs.

Company’s long-term outlook?

Recent government cutbacks along with a global shift towards advanced technology and smaller scale warfare, has reduced the demand for BAE’s traditional military hardware and this trend it set to continue.

Moreover, there is now a growing trend within emerging market countries to develop and build military hardware domestically, to avoid international restrictions and the sharing of secret technology.

With this being the case, BAE is now relying heavily on its experience and reputation to develop its consultation services division, advising customers how to implement and use their military equipment

In addition, the company is moving into the Cybercrime and high-tech electronic warfare market.

This diversification comes with higher margins but it also means that BAE has had to slim itself down as equipment orders fall.  

Indeed, while revenue has fallen 21% during the past three years, net income has expanded 2.5%, although the company has been aggressively cutting costs at the same time. Meanwhile, the company’s operating margin expanded from 7.5% to 10% during the three year period.

For me, this slimming down raises a red flag as although the company’s net income has remained remain relatively static, the company’s market where it was once dominant, is shrinking, not a good sign for a buy and forget investment.

Foolish summary

BAE was once a market leader in the field of weapons production. However, now the company is having to cut itself down to size as the world’s demand for military equipment falls.

So, although BAE is attempting to change with the times it is unclear if the company will be able to keep up with its peers.

So overall, I rate BAE Systems as a very poor share to buy and forget.

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In the meantime, please stay tuned for my next FTSE 100 verdict

> Rupert does not own any share mentioned in this article.