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BAE SYSTEMS – CONSISTENT GOOD PERFORMANCE By Howard Wheeldon, FRAeS, Wheeldon Strategic Advisory Ltd.

 

baesys07 May 15. BAE Systems confirmed this morning in the statement put out to accompany the 2015 AGM that the business has made good progress so far during 2015 and that it continues to win new business, to meet key milestones on major programmes and also that it is continuing to develop technologies and skills that underpin the future success of the business. This is a great company in my view and while it has had its share of disappointments of late it would be wrong to ignore the long list of successes.

Key points outlined in the AGM statement to investors include the £112m extension to Typhoon Availability Service contracts until early 2016 and a £165m contract to deliver capability enhancements for Eurofighter Typhoon of which the value to BAE Systems is worth £72m. In addition the company has been awarded a contract worth £859 million covering the demonstration phase for the Royal Navy’s Type 26 global combat ship programme and that is the lead up to an eventual order for the first of what is hoped will be 13 of the ships built for the Royal Navy over as many years.

Other order highlights noted by BAE Systems in the statement include selection by Boeing to provide the Remote Electronic Units for the new 777X wide-bodied commercial aircraft and that requires development by BAE Systems of a complete suite of flight control electronics for the aircraft’s fly-by-wire system and a reminder that in late 2014 the company was selected to produce the Enhanced Night Vision Goggle III and Family of Weapon Sight-Individual (ENVG III/FWS-I) programme. Worth up to $434m covering work over five years although the contract had subsequently been protested the company has confirmed that this had been denied enabling work on the contract to now proceed.

A large worldwide entity that apart from the UK has extensive operations and customer base in the USA, Middle East, Australia and elsewhere BAE Systems entered the current year with a forward order book of £40.5bn. Annual sales last year had been £16.6bn and the margin on sales was 10.2%.

Forced to adapt to defence budget cuts in the UK, US and right across Western Europe there can be no doubt that the past few years have been an uncomfortable time for BAE Systems just as it has for most western based companies engaged in defence. But the hope now is that following large scale defence capability cuts by western government over the past five years combined with the raise in level of potential threats that the position in terms of defence spending by nations has now stabilised. And there is ample evidence to back such thoughts up as larger NATO member states such as France and Germany have already indicated that they will now increase spending on defence as opposed to cutting it further.

Governments are it seems slowly beginning to get the message that the increased level of threats posed by Russia, ISIL, the sharp increase seen in terrorists incidents and the visibly increase in Cyber related attack requires increased investment on their part to counter the increased dangers. The position for the UK can be no different and while we remain in the dark over which party will form the next UK Government it would surely be foolish to imagine that whoever it is will close their eyes to the very visible increase in the level of threats that we face when SDSR 2015 is published later this year. The same is most likely true in the US and while Sequestration dangers will remain for a further year I suspect that we will see a change in attitude and approach to defence thereafter.

That BAE Systems has managed its way through such a serious period of upheaval and that it has adapted to change by investing in new technology, new business areas such as the Applied Intelligence business built around cyber security and in production facilities to make itself even more efficient at what it does is all too easy to ignore. But it is real and it is very interesting to observe change.

A recent visit that I made to Samlesbury for instance to look mainly at F-35 Joint Strike Fighter structural component production provided the opportunity of seeing some of the most advanced machining, engineering skills and Lean Manufacturing facilities that I have ever seen in my career. The same would also have to be said for production of the Stage-1 aft fuselage, vertical stabiliser, canards, and inboard flaperons and forward fuselage cockpit that BAE Systems manufacturers at the same plant for the Eurofighter Typhoon programme.

Another good example of investing in manufacturing and skills enhancement would be at Barrow in Furness where the company is building the ‘Astute’ class submarines for the Royal Navy and which I for one concluded as being extremely impressive. Barrow will of course because of the retained skills be central to the eventual replacement of the current fleet of four Vanguard class Trident submarines for which BAE Systems is heavily engaged currently in design and development integration.

It would be remiss if I were not to mention new engineering concepts and methods also being used to build the two new aircraft carriers for the Royal Navy and the remarkable and bold plan to invest in new infrastructure at Glasgow that will be used to facilitate building Type 26 Global Combat Ships for the Royal Navy. When completed this new infrastructure development will be the most modern military shipbuilding facility in the world.

The Kingdom of Saudi Arabia remains, as it has been for the past fifty years, a large and very important export customer for BAE Systems. With 72 Typhoon aircraft ordered in 2007 of which 45 had been delivered by the end of 2014 together with the 22 Hawk Advanced Jet Trainer (AJT) aircraft that KSA ordered in 2012 and that are now in build under the Saudi British Defence Co-operation Programme plus the various ground and training equipment, training support and spares current activity is intense. This is a strong long-term government to government relationship and one that has required significant investment in country by BAE Systems.

For the Sultanate of Oman BAE Systems is currently building 12 Typhoon and eight Hawk AJT aircraft and there are several other campaigns in countries bordering Saudi Arabia that individual Typhoon government partners are working on.

The recent gains by France of contract awards from India and Qatar to acquire Rafale following on from the earlier award secured for this same aircraft from Egypt has, not surprisingly, attracted much press attention of late. There can be no denial that following a long campaign in India and in Qatar by the individual member countries of the European Typhoon partnership in conjunction with their industrial partners failure to secure a win for Typhoon in either country was a huge disappointment.

But make no mistake, Typhoon will secure further orders and chances of this have been significantly enhanced now that the partner nations, Britain, Germany, Spain and Italy have belatedly agreed to develop and fit Captor E-Scan radar together with enhanced weapons delivery capability.

The point here is that upgrades to weapon systems integration and other factors designed to make this aircraft multi-role capable meaning that in effect it would allow the aircraft to simultaneously attack enemy targets both in the air and on the ground required enhanced computer power together with upgrading of weapons systems and sensors integration. These upgrades have already been retrofitted to a large number of Royal Air Force Typhoon aircraft by BAE Systems and the enhancement programme continues.  Earlier this year the partners agreed that Phase 3 Capability Enhancements that will equip the aircraft to deploy multiple precision guided air to ground weapons at fast moving targets with low collateral damage would now proceed. The prime focus of the new programme is ensuring that the aircraft is able to deploy a full variety of air to air and air to ground weapons and also that the aircraft can deliver Brimstone, Storm Shadow long-range strike missile, Meteor, Paveway 1V and ASRAAM weapon capability.

Enhancements to Typhoon weapons systems delivery capability are absolutely crucial to the winning of further export orders and they will go a long way in my view to improving the potential to sell this exceptional fast jet capability to export customers.

There is absolutely no doubt in my mind that Typhoon continues to have great export potential in terms of capability and affordability. The fundamental physical structure of this fine aircraft combined with its powerful, reliable and efficient EJ200 engines, built by a partnership led by Rolls-Royce together with the advanced electronics carried really do stand this fine aircraft out from the crowd. In true multi-role form Typhoon will be the aircraft to beat.

With a strong balance sheet, good cash flow and decent outlook across most business areas BAE Systems has not only weathered the defence cuts storm it has moved on. Forward guidance has been maintained and the strategy to maintain and grow the defence business, continue to grow the business in adjacent markets, develop the international business, enhance overall financial performance and competitive positions remains unchanged. Programme execution has significantly improved over the past five years and while margins have generally been maintained over that period the headcount has fallen by 30%. Today non UK and USA business represents 35% of BAE Systems and that will continue to grow. Long term contracts are a feature of a business such as this as are relationships. Look no further than the Kingdom of Saudi Arabia or the large part that BAE Systems plays in manufacturing components for the Lockheed Martin F-35 Joint Strike Fighter programme and that can be expected to provide revenue for very many years as evidence of this.

With R&D sustained at 8% of sales and one programme from this spend being Taranis, a partnership led by BAE Systems but involving Rolls-Royce, QinetiQ and others that involved building a demonstrator programme for Unmanned Combat Air Vehicle technology that can fly intercontinental missions carrying a variety of attack weapons with low radar profile the company has not been standing still in investing in its own future. Clearly more will need to be done and with governments more reluctant to engage in risk programmes despite the potential benefit and value to the economy there may need to be an upward adjustment by industry in the amount of programme risk that they take on in the future.

Another interesting future programme that the company is currently engaged is the £120m FCAS feasibility study on the potential for joint development of unmanned aerial capability development by France and the UK led by BAE Systems and Dassault.

Clearly Platforms and Services which in the UK, US and internationally represent two thirds of Group activity will remain the major part of the business. But growth in Electronic Systems and also in Cyber and Intelligence activities can also be expected to rise in the coming years. This is a great business with great opportunities. Of course there is still work to be done to make BAE even more efficient than it is now but that is the same in most businesses.

The point though is I believe to take the view that if defence spending by mature western nations has in the main now stabilised and if as an international company such as BAE Systems you are well engaged into countries that are raising spending in defence then you are in the right place.

hwheeldon@wheeldonstrategic.com

Tel: 07710 779785

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