With a continued focus on driving through strong and consistent operational performance across the group, first half results from BAE Systems provide investors with an excellent mix of strong financial performance and multi-year growth visibility underpinned by the huge £47.4 billion order backlog.
Combined with strong balance sheet and improved cash flow, improved net debt guidance, raised dividend together with an unchanged full-year underlying earnings outlook that targets mid-single digit growth, there is also no change in the three-year ‘Free Cash Flow’ guidance. These half year results in my view not only underpin full year expectation but also provide very strong evidence that the company is well placed to achieve medium and long-term growth.
From a programme perspective, few companies are able to see quite so far forward than BAE Systems. Order backlog on Typhoon takes the company through 2024 with significant other programme opportunities remaining. Typhoon support programmes both nationally and internationally are ongoing while F-35 build and support stretches through almost as far as the eye can see.
In the Maritime domain the Astute submarine programme stretches through the mid 2020’s while the build and future pipeline of the Dreadnought submarine programme stretches through the next two decades. Type 26 for the Royal Navy which, together with the Australian Hunter Class frigate programme, not only provide long production and pipeline visibility but other opportunities as well.
In Land Vehicles and Products opportunities in the US continue to grow as the country modernises its defence equipment and in the UK the partnership between Rheinmetall and BAE Systems offers interesting competitive based potential.
Prioritising on delivering consistent and strong operational performance for customers and shareholders alike includes not only focus on better execution of orders but also on further strengthening of the order backlog. The first half results demonstrate significant improvement being made in both domains and also, of a company that is determined to be more competitive in order to grow.
BAE Systems is not without many interesting future opportunities one of which is the involvement in ‘Team Tempest’ – the next generation combat air programme – and which it is worth recording that Sweden has recently signed an MOU with the United Kingdom committing both governments to work on a joint combat air development and acquisition programme, and of which I suspect that in coming years other countries will also join.
Elsewhere, the BAE Systems Type 26 design was also selected by the Canadian Government for its Canadian Surface Combatant programme is another great example of success that will hopefully be followed by other countries. Similarly, in the years ahead, BAE Systems large scale commitment to the F-35 build programme and its involvement with partners in the long-term F-35 maintenance, repair and overhaul programmes that will, for instance, see the UK operating as a global repair hub for F-35 are hugely positive aspects for the future.
BAE Systems Electronic Systems activities in the US are also growing fast and to that end the company is establishing new facilities in order to increase capacity in Huntsville Alabama, and Manchester, New Hampshire.
BAE Systems recently acquired Riptide Autonomous Solutions, a developer of unmanned underwater vehicles in order to secure a flexible platform for integrating its electronic solutions and mission systems capabilities. Importantly, as we enter a new and exciting phase of technology development including unmanned, Space and Artificial Intelligence (AI) BAE Systems is continuing to invest heavily in new future technologies. The 20% stake that BAE System owns in Reaction Engines which is developing a hybrid reusable rocket jet engine is another example of the company investing in its own future.
Internationally and particularly in the USA, BAE Systems remains well placed in my view to increase business in almost all of its active areas including electronic warfare, precision weapon systems, combat vehicles and F-35 Lightning.
In Saudi Arabia the company continues to work closely with industry partners and the UK Government to continue to fulfil contractual support arrangements on key European collaboration programmes. Separately, the Memorandum of Intent signed by Saudi Arabia and the UK Government in March 2018 in respect of an additional 48 Typhoon aircraft, support and transfer of technology remains under discussion.
The Qatar programme covering supply of 24 Typhoon and nine Hawk aircraft by BAE Systems continues to progress well and the company is also engaged on international work for the 28 Typhoons being constructed under contracts signed in December 2017 between the State of Kuwait and Italy and for which in this case Leonardo is the lead company.
In the UK the company delivered the 500th F-35 aft fuselage and is currently ramping up for the full production rate to commence next year. Separately, is good to see that the second of five Offshore Patrol Vessels, HMS Medway has been accepted by the Royal Navy customer and that third, HMS Trent is close to acceptance. The first Type 26, HMS Glasgow is progressing toward its first of class contractual date and that the fourth of seven planned Astute class submarines is being prepared for sea trials.
Finally in respect of the UK, with the first of class Royal Navy carrier HMS Queen Elizabeth doing everything and more that is asked of her it is good to see that the second Royal Navy carrier, HMS Prince of Wales which has been built by the Carrier Alliance that includes BAE Systems remains on track for sea trials later this year.
Allowing the final withdrawal from Royal Air Force service of the Panavia Tornado GR4 aircraft, BAE Systems is to be congratulated for the speed and programme efficiency in respect of the Typhoon weapon delivery system upgrade ‘Project Centurion’ which has allowed Typhoon to take over the role of Tornado. Last but by no means least, I would mention the now completed UK based military land vehicle design manufacturing and support joint venture that BAE Systems has created with Rheinmetall of Germany that will bring huge additional strength to both companies in their pursuit of new business in increasingly competitive markets for land systems equipment.
Group sales rose by 4% and underlying EBITA (Earnings Before Interest, Tax and Amortisation) by 9% on a constant currency basis Excluding the one-off tax benefit (BAE Systems had previously announced a one-off tax benefit of £161 million would be recognised in the first half figures – this arising from agreements reached in respect of an overseas tax matter) H1 underlying earnings per share rose by 11% to 21.9p against a previous year 19.8p.Inckluding the one-off tax benefit underlying EPS was 26.9p. Operating cash outflow was £309 million and the interim dividend was raised by 4.4% to 9.4p.
Group share of pension deficit was £4.3 billion at the half year period end but funding of the deficit recovery plans remains on track.
In respect of divisional performance Air which is generally second half weighted produced sales of £3.36 billion which were relatively unchanged on last year. Underlying EBITA was a touch lower than last year at £438 million and margins were 13% for the period. The order backlog at the 30th June stood at £25.9 billion.
Electronic Systems enjoyed significant first half year improvement posting sales of £2.1 billion, margins rising to 14.8%, cash flow of £137 million and the order backlog rising 12% to £6 billion.
Sales of Maritime related products rose by 5% and margins improved to 8.7%. Cash flow also improved and the half year end order backlog stood at £8.7 billion.
Platforms and Services (US) enjoyed much improved underlying EBITA performance of $175 million compared to a previous $77 million, cash flow significantly improved as did the end period order book which stood at $7.2 billion. While overall sales in Cyber and Intelligence were relatively unchanged H1 2019 results were impacted by a restructuring charge of £25 million taken in respect of a decision to dispose aspects of Applied Intelligence and to exit from the loss-making UK-based Managed Security Services business. Of particular note is that sales and margin performance at Intelligence and Security improved by 6% and 9% respectively.
CHW (London – 31st July 2019)
Howard Wheeldon FRAeS
Wheeldon Strategic Advisory Ltd,
M: +44 7710 779785