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BAE Systems – On Plan and On Course For Future Growth By Howard Wheeldon, FRAeS, Wheeldon Strategic Advisory Ltd.

First-half period results for 2017 from BAE Systems announced this morning reflect strong programme execution built around and from consistent strategy.

Ahead of consensus forecasts, the results show revenue, underlying earnings per share and cash flow that are consistent with company expectations. The H1 dividend is also raised to 8.8p and of importance, both order intake and backlog are ahead of the same period last year whilst at the same time, net debt is down.

BAE Systems is traditionally second half weighted in respect of performance. However, it is important to stress that despite results emerging higher than consensus analyst forecasts, there is no change to full year guidance from the company. Thus guidance is maintained with expectation of underlying earnings per share increase of between 5% and 10% over that of FY2016 while net debt is forecast to be slightly lower at year end that FY2016.

In terms of figures, BAE Systems revenue for the first-half period was £9.56 billion (H1 2016 £8.7 billion) while underlying earnings before interest, tax and amortisation (EBITA) was £945 million (H1 2016 £849 million). Earnings per share (EPS) was 19.8p v 17.4p for the period and the order backlog stood at £42.3 billion – this following strong order intake of £10.65 billion during the period. Period end net debt was £1.74 billion.

With the retirement of Ian King at the end of June, the half-year results period coincided with a change in CEO. Charles Woodburn, who joined BAE Systems as Chief Operating Officer sixteen months ago, has now assumed the role of CEO. These are very interesting times for BAE Systems and the change of CEO coincides with strong signs of a resurgence of confidence in the outlook for defence spending internationally to now be on a rising trend.

Given that the strategy developed and implemented across the whole of BAE Systems over the past eight years has undoubtedly worked well for customers and shareholders, I suspect that in the short to medium term, little will change. So, In respect of forward strategy, the words ‘evolution’ as opposed to ‘revolution’ would be my description of how BAE Systems is more likely to move forward under its new CEO through the medium term. If this view proves to be correct, then ongoing group strategy will continue to be based on maintaining efforts to ensure strong financial performance, concentration of effort on maintaining and improving operating excellence, maintaining and improving productivity and efficiency and finally, building on the developed financial performance culture that has served BAE Systems well for many years. Perhaps the real point though is that all will likely be enhanced.

BAE Systems strategy will also be about differentiating itself through investment in technology and I take the view that the future will increasingly be about focussing more on technology development in order to maintain and grow competitive advantage. In short, I expect to see BAE Systems continuing to invest more in its own future and to be continually enhancing its technology advantage. The latter is undoubtedly where the future lies.

The first six month period can hardly be described as being anything other than exciting for BAE Systems and period results demonstrate not only significant strength across almost all sections and divisions but also a rising level of confidence in the future. This is, after all, an international company and one with diverse defence interests spread across many Continents. Within the pure defence domain, BAE Systems has diverse interests spread across air, maritime and land.

Defence is and always was, a long term business and while some aspects have struggled as Government customers have chosen or have been forced to cut back on spending, the general consensus is that we have or are beginning at least to move from a transient period in defence to one in which changing circumstances and rising geo-political risks and uncertainties translate to a need to spend more on defence. Being already very well placed to meet forward challenges and having invested in its people and facilities in order to meet potentially increased demand, this bodes well for a company such as BAE Systems that has properly invested for the future.

2017 has also witnessed the start of sea trials for HMS Queen Elizabeth, the largest ship ever built in the UK for the Royal Navy this past month, signing of production contracts for the initial batch of three Type 26 frigates for the Royal Navy. Note too that all five River Class Offshore Patrol Vessels are now in build with the first, HMS Forth due to begin sea trial in Q3.

BAE Systems also received contracts for the sixth ‘Astute’ class submarine and in January, secured a large contract to supply 145 M777 ultra-lightweight howitzers to India. Important too in respect of Typhoon exportability was confirmation in July from a UK High Court ruling that the UK Government has acted lawfully in granting defence export licences to the Kingdom of Saudi Arabia.

In is H1 statement, BAE Systems also notes that the US Department of Defense fiscal year budget proposals for both 2017 and 2018 support its own medium term US business planning assumption in regard of an expectation of ramping up of production on a number of longer term programmes that BAE Systems is engaged on in the US. In relation to this the statement notes the importance of its US electronics business that have strong franchise positions in the high-technology areas of electronic warfare, electro-optics and Intelligence, Surveillance and Reconnaissance.

Apart from Aft Fuselage & Structural components, vertical fins and horizontal stabilisers produced by BAE System for the F-35 Lightning ll Joint Strike Fighter combat aircraft the company is also the supplier of electronic warfare systems. Production is now increasing and the company notes that it is well positioned to meet increases in production output over the coming years to meet the requirements of US and international customers.

Also in the US, the H1 update notes the Eagle Passive Active Warning Survivability System electronic warfare upgrade for US Air Force F-15 aircraft and which is now progressing through its engineering and manufacturing development phase. Several other important US based air, land and maritime awards and those that the company believes it is well placed to win are also mentioned.

In the UK there is a general belief that defence will remain prioritised by Government and, apart from mentioning export related deliveries to Saudi Arabia, Oman and work also underway on Kuwaiti Air Force Typhoon based subcontract work, the statement provides an update on Typhoon capability enhancement work for the integration of Storm Shadow, Meteor and Brimstone 2 missiles and development work that will enable smooth transition of multi-role capability from Royal Air Force Tornado GR4 military jets to Typhoon and notes too that Captor E-scan radar integration is continues. In addition, the company reminds that unmanned air systems activity has benefited from the UK/French government announcement of a new €2bn (£1.8bn) project to build an unmanned combat air system demonstrator following what had been a successful joint study phase. The feasibility and definition phase for this project is now under way and a proposal for the first phase of the demonstrator programme was submitted in March. Funding of £16m has been received to date.

CHW (2nd August 2017)

Howard Wheeldon FRAeS

Wheeldon Strategic Advisory Ltd,

M: +44 7710 779785

Skype: chwheeldon




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