BAE Systems (BA.) 914.2p

Gain to date: 24.2%

We flagged defence firm BAE Systems (BA.) at 736p in March 2022. This was based on the expectation a less stable world would increase the focus on defence spending and help improve the sector’s long-term prospects.

WHAT HAS HAPPENED SINCE WE SAID TO BUY?

Our thesis has played out as expected and BAE is among the top performers on the FTSE 100 over the past 12 months. Several members of NATO have responded to the greater threat posed by Russia by boosting their planned military expenditure. The company’s results for 2022 revealed an order book of around £59 billion as it secured nearly £37.1 billion of new orders – a record.

Berenberg analyst George McWhirter comments: ‘BAE has a balanced portfolio, with 45% of sales derived from services and support, and 35% from major programmes, providing revenue visibility well beyond our forecast horizon. Exposure to US growth sectors and programmes is also well diversified.’

Shrugging off supply chain issues, it was able to achieve revenue growth of 8.9% and this translated into stronger-than-expected earnings and free cash flow, the latter some 50% better than consensus expectations according to Jefferies at £1.95 billion.

However, after a strong year the outlook for 2023 which accompanied the results was less positive. Guidance for earnings growth of 5% to 7% is short of what had been pencilled in by analysts at 9% and free cash flow of £1.2 billion is well below the £1.7 billion forecast. This reflects the fact that due to the timing of payments on contracts, a significant chunk of cash was pulled forward into 2022.

WHAT SHOULD INVESTORS DO NEXT?

After a very strong run for the share price, some of which came in the immediate aftermath of the Russian invasion and before we said to buy, the shares no longer look as attractive. According to Stockopedia data the stock trades on a 2023 price to earnings ratio of around 15.5 times and, as growth starts to slow, we see a risk of the shares losing their appeal with investors. Take profit.

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