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BAE SYSTEMS – IN LINE AND LOOKING FORWARD POSITIVELY By Howard Wheeldon, FRAeS, Wheeldon Strategic Advisory Ltd.

baesys19 Feb 15. A very solid set of FY14 preliminary results is the best way to describe what BAE Systems announced to investors this morning and these reflect well not only on the company management but also on a period of large scale change that has been forced not only on the company but all those engaged in the global defence industry.

The really good news is that financial performance was perfectly in line with previous guidance from the company. Good to see as well forward guidance continues to point to steady as she goes. With a strong forward order book, with a substantial number of large and important through life support programmes to sustain it over many years to come and with increased recognition by the international community that a clear worsening of geo-political relations and a corresponding rise in conflict and tensions across the world that threaten peace and stability is a challenge that must now be addressed. And if that is true then it can only be a matter of time before western nations will be forced to increase spending on defence. When that occurs BAE Systems looks to me very well placed.

Not surprisingly and with every justification in my view FY14 results from BAE Systems have been well received by markets today. Confidence from management remains high and it seems to me that on most if not all the many large build programmes on which the company is involved nationally or internationally plus those for which it provides through life support are doing well. That in a clearly difficult year for defence and one that has required the company to further adjust to challenging market conditions it has not only delivered on promises but held margins is no mean feat

FY14 operating profits rose to £1.30bn (FY13 £806m) on revenue that was down to £16.64bn from a previous year £18.18bn. The decline in revenue reflected adverse exchange rate translation plus the anticipated volume reductions in Land & Armaments together with the one-off previous year benefit of price settlement of the Salam Typhoon contract with Saudi Arabia. This also impacted on underlying earnings before interest, tax and amortisation charges which declined to £1.70bn from £1.93bn reflecting although was broadly unchanged if the negative exchange rate translation and positive impact of Project Salem in 2013 are stripped out. Net profits for the year rose to £740m from £168 million in 2013 and the dividend was raised to 20.5p.

Given maintenance of a strong margin (return on sales was 10.2% in FY14) solid earnings performance, an order backlog of £40.5bn combined with a regrettable worsening of geo-political events that in turn seems likely to lead to a reversal of attitude by western nations toward spending on defence I view the medium and longer term outlook for BAE Systems as excellent.

For the moment the situation may well be better described as steady as she goes but with large programmes such as Typhoon, F-35 Joint Strike Fighter, Hawk, Astute, OPV’s, the two Queen Elizabeth class carriers and, longer term, the start of the Type 23 replacement programme in the form of Type 26 combined with strong export potential the longer term outlook continues to look very strong.

With several new orders and commitments announced over the past few months such as final stage of weapons integration on Typhoon and delivery of E-Scan radar together with a new Armoured Multi-Purpose Vehicle to be built in the US, integrated flight control electronics for the next generation Boeing 777X order activity has been strong. In the outlook statement the company has said that underlying earnings are expected to be marginally higher than those of 2014. Whilst the segmental outlook for UK and US Platforms and Services businesses, Electronics and for Cyber and Intelligence is mixed in terms of the forward outlook there is certainly and air of greater optimism that following several years adapting to changing and sometimes worsening market conditions that a corner has now been turned.

Note also that BAE Systems ended 2014 with a very strong balance sheet and also that the company has outperformed on cash flow expectations. The share buy-back continues and the net debt position of £1bn at the end of last year leaves the company with ample scope to continues a forward looking and progressive strategy that is little changed over the past couple of years. Net Debt stood at just above the £1bn mark at the end of last year and free cash flow was also markedly up on that of 2013.

I will not attempt to detail in full the very many segmental operational and strategic highlights for Platforms and Services (International) as these are all readily available within the results statement that can be found on the company website. But I will pick out some highlights such as the floating of HMS Queen Elizabeth last year and also the high level of ongoing work on this and her sister ship, HMS Prince of Wales. In addition a £600m Maritime Support Delivery Framework contract was awarded to the company last year. Also worthy of mention is, apart from ongoing design and development work on the ‘Successor’ Trident nuclear submarine replacement is that the third of what will eventually be seven Astute Class submarines was launched from Barrow-in-Furnace last May.

Deliveries of Typhoon Tranche 2 aircraft to the four Eurofighter partner nations totalled 16 during the year bringing the cumulative number of Tranche 2 aircraft delivered to 219 from a contracted number 236 aircraft. Eighteen Tranche 3 front fuselage sub-assemblies were manufactured in the year. In July the company was awarded a three year £72m contract by the MOD to de-risk E-Scan radar development for the fleet of Royal Air Force Typhoon aircraft and in November the four partner nations placed a £365m contract with Eurofighter for full integration of the Captor E-Scan radar onto Typhoon aircraft. The company also received a £125m contract extension covering Royal Air Force Panavia Tornado GR4 support until 2019 and a similarly important £112m Typhoon Availability Service contract was awarded in December. In addition support continues to be provided to users of Hawk trainer aircraft of which so far 998 have been built or are on order. In 2014, the Indian Navy and Air Force received four and 15 Hawk aircraft, respectively, built under the Batch 2 licence for 57 aircraft by Hindustan Aeronautics Limited. A response to a proposal for an additional 20 Hawk aircraft for the Indian Air Force’s aerobatic display team has been submitted. On the F-35 Lightning II programme, the company continues to deliver aircraft fuselages for the sixth and seventh Low-Rate Initial Production (LRIP) contracts, with a total of 45 assemblies delivered to Lockheed Martin in 2014. Contract award for LRIP 8 for 43 assemblies was received in the year and manufacturing commenced. Proposals for LRIP 9 and 10 have been submitted with negotiations to commence in 2015. Completing the air profile a two year feasibility study was commissioned by the UK and French governments covering Future Combat Air Systems technology development and Taranis, a large stealthy unmanned combat air vehicle demonstrator in which BAE Systems is a partner successfully completed the second stage of flight testing.

All the above programmes are a reminder that BAE Systems doesn’t just manufacture aircraft and systems but supports them through life. The company now has a very large and diverse portfolio of international business activity and it remains a very significant player in the US defense market be this in land and armaments, ship repair, ordnance and protection systems and now cyber security as well. Of course, with defense cuts has come the necessity of realignment of activities and BAE has in my view been quick to move with the market and adapt to change.

But with the outlook now looking toward a more stable period of spending on defence particularly in the US new opportunities will clearly arise. Large programmes in the US in which BAE Systems is currently involved include Bradley and M88 Hercules vehicles as well as ship maintenance and the Armoured Multi-Purpose Vehicle (AMPV) programme for the US Army.

Elsewhere on the International front a total of eleven Typhoon aircraft were delivered to Saudi Arabia under the Salam programme and which to remind covers a total of 72 aircraft on order. This takes the total number of aircraft so far delivered to the Kingdom to 45. Support to the operational capabilities of the Royal Saudi Air Force and Royal Saudi Naval Forces under the Saudi British Defence Co-operation Programme continues and re-organisation of portfolio interests in industrial companies in the Kingdom of Saudi Arabia has included enhancing the relationship with Riyadh Wings.

In Australia customer acceptance of the first of two Landing Helicopter Dock ships has occurred and a four-year, £100m contract was also awarded to provide in-service support for the two Landing Helicopter Docks.

The Omani navy took delivery of the third and final Khareef corvette last year and work continues on Hawk and Typhoon aircraft orders received form the same country. MBDA in which BAE Systems has a 37.5% stake secured a UK/French government order worth €600m (£466m) for the joint development and production of the Future Anti-Ship Guided Weapon. Contracts were also secured by MBDA for the Advanced Short Range Air-to-Air Missile (ASRAAM) for India’s Jaguar fast jet aircraft fleet.

While no one is about to suggest that the future will not be challenging for all those companies that engage in defence it is at last starting to look brighter. BAE Systems has not been standing still and year after year it has been making itself more competitive and efficient. That process is of course to be considered an ongoing one that is unlikely to change even when times get better. Lastly, I would have to say to the sceptics and prophets of doom that no one in my view should be in any doubt that real export potential continues to exist for programmes such as Typhoon.

hwheeldon@wheeldonstrategic.com

chwheeldon@yahoo.co.uk

Tel: 07710 779785

 

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