01 Aug 18. A further £1 billion rise in the order backlog, one that does not yet include contracts for the SEA 5000 programme in Australia or supply of Hawk and Typhoon aircraft to Qatar, both of which are anticipated in the second half of the year, confirm BAE Systems as being not only concentrating very firmly on driving strategic priorities throughout the business but also in positioning itself for future growth.
As it strengthens positions in major programmes, looks to the future in regard of technology development and innovation whilst at the same time focussing on operational performance, BAE Systems can also in my view look forward to a defence environment internationally that is once again growing.
New opportunities, new people in the business and some important internal appointments particularly in maritime and air over the past six months and that are combined with changes in organisational structure are to me based on BAE Systems deciding where it wants to be in the future. Joining the dots together is not only rejuvenating the business and placing the company where it wants to be but also positioning the company for future growth.
Opportunities abound across the BAE Systems business and it is good to see the company highlighting not only technology and a pipeline of potential opportunities available but also an intention to invest in its own future through increasing self-funded research and development over time. Collaboration remains just as important as well as we have seen recently in Team Tempest.
Even though 2018 has been regarded by management as being a year of transition and one that is looking toward the future, it is good to see that the company has stuck to its earlier formal guidance, that of flat earnings expectation for FY18. Meanwhile, despite disappointment that I will come onto shortly, what we see today is the company setting out to achieve necessary goals of operational excellence, strengthening management and in placing programme execution as the main priorities.
All in all, I take the view that we first half year results from BAE Systems should be contrasted as being more like a tale of two halves and that, notwithstanding that bottom line performance this year is unlikely to be regarded as being spectacular, sets the scene for what I believe will be a very interesting future – one built on the pure objective of achieving growth.
Back to today and given visible disappointments, particularly the one-off related events within the US ship repair business in Mobile, Alabama that have required an impairment charge to be taken, a separate contractual dispute in the US together with unfortunate performance challenges in UK Maritime in respect of problems that surfaced on HMS Forth, the first of five Offshore Patrol Vessels currently being built by BAE Systems for the Royal Navy plus also and perhaps not surprisingly following such a successful partnership build programme, the need to take a more conservative basis of margin trading on the remaining part of Queen Elizabeth class build programme, these are actually not a bad set of first half results.
Disappointments in Maritime mentioned above apart, confirmation during the first half of the year that the company secured the full £1.5bn contract for delivery of the seventh planned ‘Astute Class’ submarine together with confirmation of a further £0.9bn funding for the Dreadnought programme from the Ministry of Defence was excellent news.
The award to BAE Systems of the SEA 5000 Hunter class frigate programme for Australia is yet another superb example of the company winning a long term programme. Finalisation of the SEA 5000 award is anticipated in the second half of the year.
Additional positive points that are indicative of how BAE System is in my view positioning itself for future growth can be found from the announcement that Electronic Systems ended the half year with a record order book. Within what is a still fast growing sector, BAE Systems is already a key player and given what I imagine to be scale of opportunity available, I suspect that we will see this part of the business continue to provide strong growth in the years ahead.
Also, in respect of the company positioning itself for future growth, suffice to say that the Air sector has also had a very particularly interesting first half of the year. Having signed agreements to supply 24 Typhoon military jets, training and support to the State of Qatar in December2017 and for which financing conditions and initial payment is anticipated in the third quarter of this year, Qatar has subsequently added in supply of nine Hawk aircraft.
With F-35 production and support continuing to ramp up and with the fleet of aircraft in service continuing to grow this, together with a still growing Typhoon support programme bodes well for the future.
The Air sector business has also benefited from the company being selected to deliver the Australian Jundalee Operational Radar Network upgrade programme and from the signing by the UK Government and Kingdom of Saudi Arabia of a ‘Memorandum of Intent’ for the supply of 48 Typhoon aircraft and for which finalisation discussion are ongoing. Importantly in respect of longer term benefit, the recent launch of the Combat Air Strategy in the UK and which included confirmation of the ‘Team Tempest’ partnership arrangement for the development of the next generation combat jet will lead BAE Systems into a new and very interesting development phase.
Another positive is that despite analyst expectations to the contrary, restructuring of the Applied Intelligence business is producing positive result with BAE Systems confirming that results for the first half of the year are much improved. Further improvements are targeted and together with high tempo of bid activity in US Intelligence and Security including in margins and cash performance, the outlook for Cyber and Intelligence business area is beginning to look very good.
Although BAE Systems first half results show a respective 5% and 7% decline in revenue and operating profits, this in no small way due to the previously confirmed decline in Typhoon military jet production. However, it is worth noting here that the Qatar order will stabilise the position and although the ‘Memorandum of Intent’ signed with the Kingdom of Saudi Arabia requires finalising, this further improves the outlook. Other Typhoon campaigns such as Belgium are also ongoing.
In respect of financials, while there was a rise in net debt to £1.9bn it is pleasing that once again group share of the net pension deficit has declined – this time by £0.9 bn to £3bn. Net assets also rose by £1bn to £5.9bn and the interim dividend was raised by a further 2%.
Again, worth noting here is that while the company posted a 2% first half-year decline in underlying earnings per share to 19.8p, that on a constant currency basis earnings per share were actually up by 2%. Note also that the tax rate was down and also that the company has stated that it anticipates over the full year there will be further benefits from exchange translation.
Summing up the first half of the year BAE Systems Chief Executive, Charles Woodburn said in the stamen that “We have made good progress in the first half strengthening the outlook through significant wins on the Australian SEA 5000 and US Amphibious Combat Vehicle programmes. These, combined with the launch of the UK Combat Air Strategy, provide good momentum into the second half and beyond. Operationally, there have been some notably strong performances in our Electronic Systems and Air sectors, but also some disappointments on certain long-standing programmes in Maritime and Platforms & Services (US), where we have now taken steps to strengthen management and improve programme execution. In this transition earnings year, our Group earnings guidance is maintained and, with a large order book and a positive outlook for defence budgets in a number of key markets, we have a strong foundation to deliver growth and sustainable cash flow.”
An honest appraisal of where BAE Systems is today and one that is equally about an intention to position the company for growth tomorrow.
CHW (London – 1st August 2018)
Howard Wheeldon FRAeS
Wheeldon Strategic Advisory Ltd,
M: +44 7710 779785