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BAE Systems Looks To Future With Increasing Confidence By Howard Wheeldon, FRAeS, Wheeldon Strategic Advisory Ltd.

Having achieved results that were not only in-line with previous company guidance but also in the case of certain activities, ahead of guidance there was very little to be found that would disappoint markets within BAE Systems FY16 results today and in mid-morning trade the shares were up over 2%.

Importantly, underlying EBITA*at £1.9 billion actually represented an increase of 7% over that of last year on a constant exchange basis. Operating cash flow was also sharply ahead of last year and while the pension deficit had, as previously shown, increased during the first half of the year there was no further change recorded during H2. Importantly, net assets also ended the year around 14% ahead of those reported last year and the full-year dividend for 2016 was also slightly ahead. Net debt at £1.5 billion was a touch above last year but of the many positive aspects to be found in these results, order backlog having increased by £5.2 billion during the year meant that this stood at £42 billion at year end.

While the roughly £1 billion of revenue increase to £19 billion noted within the FY16 results is due primarily to currency translation impact, performance across the bulk of group activities has for the most part improved. Noticeably, margins in Electronic Systems and within Platforms and Services both in the UK, US and Internationally, all improved.

Management guidance for FY17 anticipates underlying earnings per share to be in the region of 5% to 10% higher and in terms of divisional performance the outlook indicates a mix of generally positive to at worst, stable expectation.

I had written yesterday following the announcement of board changes due to take place at the half way point of the current year (copies of all previous related comment available on request) so I will not repeat these here other than to say that CEO Ian King will leave the company in very good heart having achieved much that he can be proud of during his tenure in office whilst at the same time, new CEO, Charles Woodburn will inherit a business that is not only very fit for purpose but very much looking toward growth.

Operationally and financially, BAE Systems is in very good health and in respect of the short, medium and long term outlook period, I for one remain very positive. Yes, there are issues to be resolved – there always are – and we must be mindful as well that achieving contract awards in a highly competitive environment and one in which the playing fields for those that compete are not exactly level, can and often is a very frustrating process.

Emphasis on improving programme execution, investment in technology, people, ideas and talent combined with strengthening core business franchises are just some of the legacy that under Ian King’s leadership BAE Systems has achieved. This together with having a broad, well-established geographic mix of related business activities leaves the company as far as I am concerned very well positioned for the future growth and shareholder reward. Add to this the pressure on western governments to spend more on defence and the already visible increase in defence spending on defence by Middle East and Asian based nations in response to the increased geo-political concerns, fears and threat, BAE Systems is well positioned to benefit in the years ahead.

In the US the outlook is one is hopefully of overall defence budgets returning to growth. In Europe to the expectation is that gradually defence spending will rise. The UK has already partly embraced a need to increase defence spending but I believe that it will be forced to further increase spending on defence very soon. Middle East based countries together with countries such as India, Japan and Australia are all significantly already or planning to increase spending of defence just as are many Asian countries and Australia too. This is true recognition that the level of threats against those that seek only peace and stability has significantly risen in recent times and that no country can afford not to have adequate levels of defence capability.

Translated in respect of an outlook for BAE Systems, this should mean that the Land Businesses being well positioned for growth and in my view that air and maritime business will see the beginnings of new activity. Meanwhile, the Electronics Systems and Ship repair business segment of BAE Systems in the US are now performing well and in the UK, benefits from £1 billion order intake in regard of Kuwait Typhoon order together with ongoing Typhoon capability enhancement work, the F-35 Joint Strike Fighter production rate now increasing combined with MRO&U (Maintenance, Repair, Overhaul and Upgrade) hubs award which is really good in terms of the longer term outlook, the outlook is good.

Hawk deliveries have also commenced to Saudi Arabia together with renewal of SBDCP (Saudi-British Defence Cooperation Programme) support contracts and within the Maritime arena, Astute submarine production continuing and work on the Dreadnought submarine class production now beginning, continuation of work on the two Queen Elizabeth class aircraft carriers plus the anticipated first cut of steel on Type 26 Frigates during the middle part of this year, the outlook period is further enhanced.

Importantly, UK activities in the air domain include Typhoon aircraft assembly along with integration of Captor E-Scan radar and delivery systems to accommodate Storm Shadow, Meteor and Brimstone 2 missiles onto the platform combined, as mentioned above, with increasing production of rear fuselage assemblies for the Lockheed Martin F-35 Joint Strike Fighter Lightning II military aircraft programme. These are all excellent programmes and combined paint a strong picture that bodes well in terms of performance over short, medium and longer term outlook period. Key to margin performance is good programme execution and on that score BAE Systems has clearly made great strides forward.

Other highlights to note in terms of future perspectives for the company include the announcement last year in regard of the F-35 Programme Office award to BAE Systems and partners (Defence Electronics & Components Agency and Northrop Grumman) of the global repair hub that will provide maintenance, repair, overhaul and upgrade work on F-35 avionic and aircraft components. I have written previously on this very valuable award signaling a view that it could well be worth many billions of pounds to BAE Systems and its partners over the long anticipated F-35 through-life period – again this is available on request.

In respect of international markets, Typhoon and Hawk deliveries continue to the Kingdom of Saudi Arabia and as previously mentioned, the achieved 5-year SBDCP service support contract renewal covering the period through to 2021 is hugely important.

Worth noting too is that BAE Systems Australian business activities are now stable, following the various actions taken during 2015, and that in India the M777 Howitzer contract was secured last year and that negotiations continue with the Indian Government on batch 3 Hawk aircraft. MBDA which is one-third owned by BAE Systems performed well and a strong order backlog underpins the outlook for good future growth. Finally and again as I signaled in a separate report a month ago, the UK/Turkey defence deal that will see BAE Systems design and develop the TF-X military fighter aircraft for the Turkish government has huge long term potential for the company. Worth over £100 million initially, this could be the start of something very big in the years ahead. Last but by no means least here is the Anglo/French agreement in which BAE Systems and its French partners are charged with design and development of un-unmanned Future Combat Air System prototype aircraft as part of a £1.54 billion deal agreed between the two nations.

While Applied Intelligence activities had a difficult year the outlook following substantial investment in product development looks to be much improved. In addition, new multi-year service contracts have been secured within Intelligence and Security activities and the outlook here appears to be reasonable within what is considered to be a competitive market

*(Earnings before amortisation and impairment of intangible assets, finance costs and taxation excluding non-recurring items)

CHW (23rd February 2017)

Howard Wheeldon FRAeS

Wheeldon Strategic Advisory Ltd,

M: +44 7710 779785

Skype: chwheeldon

hwheeldon@wheeldonstrategic.com

@AirSeaRescue

 

 

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