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BAE Systems – Positioning For Future Growth By Howard Wheeldon, FRAeS, Wheeldon Strategic Advisory Ltd.

baesys12 Nov 15. Repositioning of BAE Systems Military Air & Information (MAI) business activities to better ensure maintenance of Typhoon production continuity and cost competitiveness over the medium term together with confirmation of requirement for 22 Hawk Advanced Jet Trainer (AJT) Aircraft plus associated ground equipment and training aids for the Royal Saudi Air Force and that will form part of an enhancement to the Kingdom’s overall pilot training capacity are two extremely important aspects contained in the Q3 Trading Statement announced by the company earlier today.

With a key messages that include effectively unchanged sales and earnings guidance BAE Systems shares were not surprisingly well ahead during early morning trade. This was indeed a positive underlying trading statement and one that reflected a mix of intention to take further necessary cost related measures in certain activities whilst at the same time pushing forward an interesting and positive view on others.

It seems to me that aligning Typhoon production rates with planned delivery schedules for current and anticipated orders is a timely and very sensible move. As a result, 371 jobs are to be lost at MAI from a total workforce of around 13,000 employees. Regrettable though job losses such as these are they are clearly necessary in order to avoid any break in production and to ensure that the MAI operation remains competitive. In any event, given the excellent record that BAE Systems has long had in relation to managing employment reductions, I suspect that the vast majority of jobs that are planned to go will be achieved through voluntary redundancy.

Typhoon is undoubtedly performing very well in service with the various partner and export customers and it is pleasing to see that a significant number of capability enhancements are now being made by partner governments and export customers. These include a programme of new weapons integration and delivery systems, new sensors and significant radar enhancement that will ensure that from a mission perspective Typhoon is unmatched in terms of the capability that it is able to deliver. Note also that following completion of successful negotiations with the Italian Eurofighter partners that Kuwait has recently announced an intention to acquire 28 Typhoon aircraft. BAE Systems is right in my view to remain very confident about future Typhoon programme export success and to that end the company continues to be very actively engaged in various sales discussions in Asia and Gulf regions.

While the company has chosen to announce plans to align production rates in order to cover medium term customer delivery expectations note that Typhoon sales planning assumptions have been left unchanged.

Confirmation also today of a requirement from Saudi Arabia for an additional 22 Hawk AJT aircraft together with training and support requirements will take total Hawk sales to over 1,000 units since the original programme began. That is a remarkable achievement and the Hawk story is far from being over yet. Other international Hawk orders continue to be anticipated and I continue to be very optimistic that both Typhoon and Hawk will enjoy further export order success in the year ahead.

Another important aspect to note is that sustainment of aircraft such as Typhoon, Hawk together with older fast jet programmes such as Panavia Tornado represent a very significant and important part of BA Systems revenues. Typhoon sustainment and which as a large military aircraft programme will see aircraft remain in service and operation for the next 30 to 40 years, is already thought to comprise just under half programme revenues.

It is always important to realise that in the highly competitive world of large defence programmes and which customer government funding is made all the more difficult die to budgets being squeezed means that military equipment sales always appear to take far longer than one would like. It can take many years from the start of a sales and negotiation process to achieve success. Hard work, effort and significant patience are required and it can take years before success is finally achieved. Export sales have always been hard won but in Typhoon the four partners really do have aircraft capability regarded by all those who use it as being the most formidable and advanced fast jet aircraft capability in military service outside of the US. And with the Hawk AJT considered the perfect lead in jet trainer aircraft for both Typhoon and F-35 Joint Strike Fighter, BAE Systems remains very well positioned in my view to win further orders for both.

Ahead of the UK SDSR 2015 defence and security review announcement (the review is anticipated to be published and announced on Monday 23rd November) BAE Systems is unable to give much additional clarity over anticipated UK sales activities. However, with the key components of SDSR 2015 likely to be built on Innovation, Prosperity Agenda and Training and with the key underlying intent being capability enhancement for the UK armed forces as opposed to capability reduction I remain positive in terms of key outputs.

With an order backlog of £37.3bn confidence in the future prospects of BAE Systems is well underpinned. Confirmation today that growth combined with improving prospects in other group areas such as cyber security and commercial electronics are further positives. Other points raised in the trading statement today impact on BAE Systems US and Australian activities:

USA

In the US, the recently approved Congressional two-year budget deal will most likely lead defence spending being increased above the previous budget cap limitation. The geo-political world is also becoming more unstable and there appears to be increasing realisation that spending on defence equipment capability has in some countries been slashed too far. Even so there will be no immediate improvement in certain segments of defence activity. In the US for example, the BAE Systems ship repair business is being forced to respond to changes in the profile of US Navy activity workload. To that end activity at the Norfolk, Virginia based North Atlantic ship repair is being downwardly adjusted to reflect lower workloads anticipated during 2015/16 although, following investment in capital facilities at the Group’s San Diego shipyard on the Pacific Coast, activities here are anticipated as more likely to increase.

Also in the US and following a high level of expressed external interest, during April this year BAE Systems announced a strategic review to look at the manpower and services activities it has within the US-based Intelligence and Security (I&S) sector. That review is now complete and it has been concluded that retaining the businesses will deliver greater value for BAE Systems. The business continues to perform very well and has enjoyed strong order intake.

Finally from a US perspective BAE Systems was awarded a recent contract to provide the digital electronic warfare system for the US Air Force’s EPAWSS programme. This requires upgrading up to 450 F-15 aircraft. My understanding is that the contract is expected to rise beyond $1 billion over the full life of the programme.

Australia

Whilst BAE Systems has welcomed the announcement by the Australian Government of the intention to launch a naval shipbuilding strategy, it remains unclear whether the results of such an initiative will be sufficient to provide for the viability of the Williamstown, Melbourne shipyard.  Given these concerns and with no near-term prospect of work beyond the current Landing Helicopter Dock Programme together with the Air Warfare Destroyer block manufacture, both of which are drawing towards a close, internal cost based saving action is to be taken. With no near term replacement business in prospect the company has decided to further reduce headcount and to consolidate the number of existing operating divisions from 3 to 2 in order to reduce costs and remain competitive. A non-cash impairment of the carrying value of the Williamstown shipyard assets will be charged to the Group’s 2015 results.

Shipbuilding is a relatively small part of the Australian business and the bulk is made up of maritime, air and land support including maintenance, training and providing intelligence solutions to the Royal Australian Air Force, the Royal Australian Navy and the Australian Defence Force.

All in all, a good day for BAE Systems and one that although of necessity remaining both sensible and cautious also delivers a view that the company is positioning itself well for future growth.

CHW (London 12th November 2015)

Howard Wheeldon FRAeS

hwheeldon@wheeldonstrategic.com

Tel: 07710-779785

 

 

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