BAE Systems Has Strong Government Support For Growth

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BAE Systems plc raised FY24 sales guidance to 12-14% and EBIT margin to 12-14%, driven by strong performance across all segments and operational efficiencies.Significant contracts include £25b order ...

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Management increased their sales guidance for eFY24 by 200bps to 12-14% as a result of the strong performance across all segments. Management also increased its EBIT guidance by 100bps to 12-14% given the strong sales growth and improved operational efficiencies. Given the strong organic and inorganic growth outlay for the Aerospace & Defense firm, I recommend BAESY shares with a BUY rating and a price target of $94.68/share at 14.34x eFY25 EV/EBITDA. BAE Systems Operations All financial figures are in GBP. BAE Systems booked in £25b in order intake YTD, an increase when compared to 1h23 of £21b. This includes $493mm of M109 Self-Propelled Howitzers and M992A3 Ammunition Carriers that will be delivered in 1h25 through mid-2026, $184mm contract award for 48 additional Armored Multi-Purpose Vehicles for the US Army, $440mm for Bradley Fighter Vehicles, 200 of which are A4 variants, $460mm for the AN/ARC-231/A Multi-mode Aviation Radio Set for the hardware components, repair services, engineering, logistic support, and development for the US Army rotary-wing aircraft, and €2.5b as part of its MBDA JV. BAE Systems has also had a number of successful space program projects in e2h24. These include the launch of NASA’s Europa Clipper spacecraft. It is planned to orbit Jupiter and observe one of its moons using the Europa Thermal Emissions Imaging System and a completed test on the Nancy Gracy Roman Space Telescope for NASA’s Goddard Space Flight Center. The firm also launched its 6th Astute Class submarine for the Royal Navy and launched the 2nd Type 26 frigate for the Royal Navy. Management suggested in its update that defense spending in BAE System’s markets is supporting the firm’s existing programs for growth opportunities across all segments. Accordingly, the UK government has cleared the path for increased Aerospace & Defense spending to 2.5% of GDP. The US defense budget is also expected to grow in 2025 and beyond, reaching $817b in 2024 and $849b in 2025. BAE Systems also benefits from the AUKUS program, a joint military program between Australia, the UK, and the US that was created to strengthen each government to support security and defense interests as well as build ongoing bilateral ties. As part of the AUKUS program, BAE was selected to build Australia’s new nuclear-powered submarine fleet to support joint military operations. One headwind faced as it relates to this is that one of the submarines caught fire at one of the company’s shipyards in Barrow-in-Furness.   DoD In February 2024, BAE Systems completed its acquisition of Ball Aerospace for $5.5b, creating the firm’s new Space & Mission Systems business. As part of this deal, BAE Systems raised $4.8b of debt to finance the deal. Management suggested that the integration will provide positive cost & top-line synergies in the medium term as the firm integrates its electronics systems together. BAE Systems is realizing cost synergies ahead of plan as the combined firm’s global buying power has improved. Accordingly, the deal is expected to realize 10% in annual sales growth paired with an 11% operating margin. On September 3, 2024, BAE Systems acquired Kirintec, a UK-based cyber & electromagnetic activities company that has expertise in counter-implosive explosive devices, counter uncrewed air systems, and electronic warfare products and solutions. As part of management’s growth strategy, BAE Systems will be increasing its self-funded R&D above 2023 levels. Corporate Reports Electronic Systems Electronic Systems experienced 35% year-over-year growth, driven by the SMS business acquisition. Organic growth for 1h24 was 11%, driven by precision strike & sensing and commercial avionics. BAE Systems has several programs that will benefit this segment going forward. These include its contract to deliver 7 Network Tactical Common Datalink production systems supporting real-time intelligence, surveillance, reconnaissance, and command and control for the US Navy. There is a $1b contract to provide new EA-37B aircraft while upgrading the existing EC-130H fleet, and a contract to deliver on Lot 16 electronic warfare systems for the F-35 Lightning II program, among others. The firm also signed a memorandum of understanding with Eaton to deliver electric driver solutions for heavy-duty commercial vehicles. This also includes a partnership agreement with GILLIG to supply its electric drive technology to power GILLIG’s hydrogen fuel cell transit buses. BAE Systems is positioned to continue to expand its capabilities for the US and international customers to build on its F-35 Lightning II, deliver F-15 upgrades, and upgrade the M-Code GPS and classified programs, among others. Management also suggested that BAE Systems will expand on its precision weaponry, space resilience, hyper-velocity projectiles, and autonomous platforms. Platforms & Services Platforms & Services grew by 13% driven by increased vehicle production in its Hägglunds and Combat Missions Systems businesses. BAE System’s Combat Mission Systems team is producing combat vehicles and naval programs at higher volumes, potentially resulting in stronger and more durable growth going forward. The firm received additional awards for its CV90 combat vehicles for Sweden and partner nations. This will include both new builds and upgrades to the current fleet of CV90s. BAE Systems is also in the process of finalizing a new 10-year contract for the US Army’s Holston Army Ammunition Plant. The firm is also operating and modernizing the Radford Army Ammunition Plant under contract through 2026. Air Air grew by 7% on a year-over-year basis in 1h24, driven by increased activity on support programs and MBDA. BAE Systems continued delivering on its contract with Qatar for Typhoon aircraft. In 1h24, the firm delivered an additional two Typhoon aircraft, for a total of 20 aircraft in service. BAE Systems is making progress towards partnering with its Japanese and Italian partners on GCAP. The firm secured significant orders for its ASTER missiles for the Italian Armed Forces, and Patriot GEM-T missiles for the NATO Support and Procurement Agency. It also expanded its Sea Ceptor with common Anti-Air Module Missile to include the Polish, Swedish, and Kingdom of Saudi Arabian navies. Maritime Maritime realized a 14% year-over-year growth rate as a result of increased activity on the Hunter Class Frigate Program. The firm constructed the first 3 of 4 Dreadnought Class Submarines and the final two Astute Class Submarines at Barrow-in-Furness. The firm also began construction on its first four City Class Type 26 frigates, with a 5th ship forecast to commence construction in e2h24. Management noted that the outlook for the Maritime segment remains positive with durable, long-term contracts in place. Cyber & Intelligence Cyber & Intelligence realized a 4% year-over-year growth rate. This segment is supported by government customers in the US DoD, federal agencies, and civilian organizations. Management noted that Cyber & Intelligence has a robust pipeline for enterprise customers, Air & Space Force Solutions, Integrated Defense Solutions, and Intelligence Solutions. In 1h24, this segment was awarded multiple contracts with a total contract value of over $600mm. As part of its acquisition of Ball Aerospace, BAE Systems brought in Topaz Intelligence to expand its Modeling & Simulation portfolio to provide intelligence-as-a-service to help with decision-making for customers. BAE Systems Financial Position Corporate Reports Management raised their guidance for eFY24 results from 10-12% to 12-14% for revenue growth and increased their EBIT margin guidance from 11-13% to 12-14%. Management is also forecasting higher capital investments in eFY24 when compared to FY23 with a focus on maritime, munitions, and the firm’s Swedish combat vehicle production capacity and capabilities. For eFY24, I’m forecasting BAE Systems to generate £28b in net revenue, with a diluted EPS of £0.67/share. I’m forecasting revenue to grow to £31b in eFY25, for a diluted EPS of £0.75/share. Risks Related To BAE Systems Bull Case BAE Systems is in a strong position to cater to the global unrest as well as national co-operative partnerships, such as the AUKUS. The firm’s recent acquisition of Ball Aerospace will bolster BAE System’s SMS presence at a time when space mission investments remain critical. I believe that the new US administration will continue to invest in mission-critical equipment as geopolitical tensions heighten, especially with the recent news of President Biden allowing for Ukraine to use US-supplied long-range missiles in Russia. Bear Case The Aerospace & Defense industry is extremely competitive and can potentially be volatile as new alliances are created as the global unrest continues. The industry is also expanding with new startups, creating a more competitive environment for novel technology. This may lead to more competitive bidding, resulting in tighter margins. Valuation & Shareholder Value Corporate Reports Figures were translated using the conversion rate of 1.264:1. In 1h24, BAE Systems completed its £1.5b 2022 share buyback program and commenced its 2024 buyback program for £1.5b. In addition to its robust buyback program, BAE Systems pays out a $1.60/share forward dividend rate for a yield of 2.46%. Seeking Alpha Looking at company comps, BAESY trades at a significant discount to its peer cohort at 12.34x EV/EBITDA, well below the average of 22.22x. This discount may provide room for share price growth going forward, which may be bolstered through the firm’s buyback program. Valuing the firm using an internal valuation model based on my forward estimates and the stock’s historical trading premium, I value BAESY shares at $94.68/share at 14.34x eFY25 EV/EBITDA. I recommend BAESY shares with a BUY rating. Corporate Reports  Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. 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