Despite what can only be described as having been an extremely challenging year, BAE Systems has provided investors with FY2020 results that demonstrate not only another year of solid financial performance improvement but also one that the company has continued to lay strong foundations to achieve more growth.
Strong leadership combined with having a consistent and well-defined forward strategy are vital components for future growth – BAE Systems in my view has both in spades. This is a company that is consistent and as good as its word. It is also one that takes its social responsibilities very seriously and that has bent over backwards to support employees, customers and governments in the various countries that it operates during these very difficult times through the global C-19 pandemic.
In his end year statement, CEO Charles Woodburn said:
“Thanks to the outstanding efforts of our employees and close cooperation with our customers, suppliers and trades unions, we have delivered a strong set of results against a challenging backdrop of the global pandemic. Throughout 2020, we focused on keeping our people safe and supporting our communities, whilst continuing to deliver for our customers. In 2021, we will continue to drive operational performance, progress our sustainability agenda and invest in high-end discriminating technologies to meet our customers’ priorities, which will ensure we are well positioned to grow the business and contribute to the economic prosperity of the countries in which we operate.”
With revenue, operating profits, underlying EBITA and earnings per share (excluding the one-off FY19 tax benefit) all ahead of last year and importantly, free cash flow (excluding the £1 billion FY20 pension contribution) also well ahead of last year BAE Systems has not only weathered a very difficult year well it has placed itself in an excellent position to achieve more growth in the year ahead.
Free cash flow has always been an important measure of financial performance and it is interesting that the company is emphasising that this is seen as the key performance measure for utilisation of cash at the group level.
The total 37.5p dividend paid for the year includes the interim payment of 9.4p, final payment of 14.3p together with the originally proposed but Covid related deferral of the 13.8p final dividend for FY19.
In respect of forward guidance, the company said in the end year statement that “With a strong year behind us against a challenging backdrop of the global pandemic, we look forward to another year of top line growth, with a year of margin expansion and good cash flow”. Guidance provided for FY21 emphasises on expectation of continued top line growth expectation – excluding foreign currency impact sales – which is anticipated to rise in the 5% to 7% range with underlying EBITA and EPS increasing in a range of 6% to 8% and 3% to 5% respectively with free cash forecast to be in excess of £1 billion.
The company has also announced a three-year free cash flow target for the years 2021 to 2023 to be in excess of £4 billion. Finance costs are expected to be approximately £270m with an effective tax rate expected to be around 18%.
Order intake increased to £20.9bn and the company ended the year with a roughly unchanged order backlog of £45.2 bn.
Brad Greve who took over as Finance Director from Peter Lynas has already made his mark emphasising that the emphasis on free cash flow will be stepped up. In addition, the company has announced that during the current year the underlying EBIT profitability measure will be adopted, this to include charges relating to software and development intangible amortisation, in place of the underlying EBITA measure believing that this better reflects the measure of underlying profitability. Underlying earnings per share will also be recalculated to ensure consistency with the updated operational profitability measures. Revised guidance for these updated measures will be issued in due course. The change in profit measure has no impact on the Group’s existing business performance or cash guidance.
In respect of the balance sheet, net debt increased to £2.7 bn – this following issue of a £1 bn bond in respect of previously announced additional £1 bn contribution made to the UK pension fund together with £1.7 billion in respect of the acquisitions of Airborne Tactical Radios and Military Global Positioning Systems businesses.
Strategy
As CEO of BAE Systems for the past three-year, strategy under Chares Woodburn has been extremely consistent. The basis has and remains execution on the key strategic objectives of operational excellence, driving forward better competitiveness and efficiency across the group, continued realisation that technological innovation is vital for the successful delivery of the order backlog and in delivery of future growth and a high‑performing sustainable business. Continually pushing operational performance improvement is central to the BAE Systems strategy in order to ensure delivery of the order backlog and make ongoing improvement in long-term cash generation.
The past year has seen two extremely important acquisitions in the US at a combined cost of $2.2bn (£1.7bn). Both the Military Global Positioning System and Airborne Tactical Radios business acquisitions were opportunistic, these arising out of the Raytheon and United Technologies merger. Both are considered to be strategically attractive and complementary to the Electronic Systems portfolio and the company believe they represent unique opportunities to purchase high quality, technology-based businesses with market-leading capabilities and long histories of innovation in their respective fields. Both businesses are performing well and the integrations are progressing smoothly, benefiting from positive levels of engagement by the teams.
As noted above, BAE Systems made a £1bn one-off cash injection into the UK pension scheme in order to accelerate the deficit reduction and provide increased certainty to all stakeholders. From a business perspective, it is anticipated this action will provide additional cash flow looking forward and therefore opportunities for further generation of shareholder value.
BAE Systems has long proven to be a resilient company and one that has long-term strength from its many programmes, different technologies, customer relationships and sustainability agenda and over the years the company has maintained its strong sales balance between production and aftermarket services.
The geographic mix of the business has continued to evolve as US businesses have grown whilst UK and Kingdom of Saudi Arabia revenues remained stable. The geographic mix and reach, the programme spread and longevity of the positions meaning that the company is not dependent on a small number of programmes, are considered to be key factors in future resilience and strength of forward outlook.
Covid-19
I will not dwell on this but suffice to say that BAE Systems has been rigorous in actions taken to protect the safety and wellbeing of employees through this difficult time. In doing so it has built resilience over what has been a prolonged period of uncertainty. In addition, the company has coordinated closely with our supply chains to mitigate disruptions where possible and maintain resilience, in some cases advancing payments where required. Overall, response across the supply chains has been outstanding as also has also been the exceptional level of support for the defence industry from the governments in the company’s key markets particularly in respect of prioritisation of capabilities, cash flows, recognition of the need to maintain strong supply chains and collaborative working to maintain critical defence and security programmes.
It is also worth recalling here that the company was very quick in the actions it took to support governments and communities in the countries it operates in order to assist wherever possible in how they could better respond to the pandemic. In the UK and internationally BAE Systems deployed 3D printing capabilities and collaborated with many in its own supply chain and also donated more than 150,000 items of Personal Protective Equipment (PPE) to healthcare workers in both the US and the UK. The company also played a major role supporting ventilator production as part of the VentilatorChallengeUK consortium. In addition, the company supported communities in its principal markets through the provision of online educational resources for young people, as well as providing financial support to healthcare providers and local charities in order to better enable them to provide care packages and food relief to the most vulnerable. Much of the extensive outreach work would not have been possible without the considerable support of BAE Systems employees who volunteered their time and skills to help local relief efforts.
Evolving to A Sustainable Business
In the results statement BAE Systems emphasised its intentions in regard of achieving a forward sustainable business strategy and importantly, achieving net zero greenhouse gas emissions across its operations by 2030. The message from the company is worth repeating in full here:
“Sustainability is important to us and our stakeholders. We recognise that the way we do business and the actions and behaviours we demonstrate are vital for the future strength of our business. The long-term outlook for the Company and the defence industry means we need to anticipate change and ensure that we can continue to improve upon what we do today, and into the future. We are committed to building a sustainable future by having a clear sustainability agenda focused on valuing and developing our people, making a positive social and economic contribution to our communities, developing innovative technology and collaborating with our supply chains and reducing the environmental impacts of our operations and products. We have set ourselves the target of achieving net zero greenhouse gas emissions across our operations by 2030. All of these are underpinned by sound governance at the core of our business. We will continue to review ways to integrate sustainability practices holistically into our business, driven through, and aligned with, our strategic objectives as we look to develop sustainable solutions to meet ever-evolving customer requirements. This sustainability agenda is fundamental to our business performance and aligns stakeholder priorities with the Group’s Environmental, Social and Governance (ESG) risks and opportunities so that we can drive the success of the business for the benefit of all of our stakeholders”.
Operational Performance
The end year statement from BAE Systems makes very interesting reading and it is particularly pleasing to note that Applied Intelligence has performed well. In the US the combination of acquisitions and organic growth in US defence electronics business delivered another standout performance in 2020 – and particularly within core franchise positions in the high-technology areas of electronic warfare, precision-guided munitions, Intelligence, Surveillance and Reconnaissance, and electro-optics. The Electronic Systems business closed with a record order backlog supplemented by the acquisitions.
Within Electronic Systems, our Controls and Avionics franchises in the civil aerospace market of engine and flight controls have not surprisingly been negatively impacted byC-19 and these have businesses have been scaled back appropriately.
Platforms & Services (US) work is predominantly on military contracts. Due to operational and supply chain related impacts from C-19, some schedule adjustments have occurred on the fixed price contracts in US Ship Repair and on the less mature combat vehicle programmes such as the Armored Multi-Purpose Vehicle. The Combat Mission Systems business continues to make progress towards achieving consistent quality and production throughput across multiple programmes as the investment in new production capabilities, processes, and applying lessons learned take hold.
The US-based Intelligence & Security business delivered a highly resilient performance in the year and maintained its bid pipeline to deliver an enhanced backlog position at year end.
As already mentioned in respect of the Applied Intelligence business, the UK Government division performed well, driving the whole business back into a profit. During the year disposal of the Applied Intelligence US-based software-as-a-service business was completed and the company exited the UK-based managed security services business.
In the Air sector profitability was impacted in the second quarter- this again mainly due to C-19 related impacts. The Air sector responded to deliver a strong overall operational performance. Highlights included the meeting of key milestones on the Qatar build programmes, preparations for the continued ramp up of F-35 production and the delivery of in-service support on Typhoon, Tornado and Hawk for international customers. The Tempest programme is progressing at pace, with Tempest partners currently working on more than 60 technology demonstrations.
In Maritime, significant progress was made in operational performance and, working closely with the Royal Navy, delivery of a number of key milestones. The fourth Astute Class submarine, HMS Audacious, was accepted having departed the Barrow-in-Furness site in April and the final two Offshore Patrol Vessels (OPV’s) HMS Tamar and HMS Spey, were accepted by the Royal Navy. Work to bring the Queen Elizabeth Class Carriers to operational status continued. Work on the first two Type 26 vessels for the Royal Navy continued apace as does work on the Dreadnought programmes – these last two programmes being the mainstay of the Maritime business envisaged over the next decade.
Air
- Contract secured to support the production of 38 Typhoon aircraft for the German Air Force
- Qatar Typhoon and Hawk aircraft programme met its contractual milestones in the year
- F-35 programme Lots 12 to 14 contract definitised following price agreement. 126 rear fuselage assemblies completed in the year, below the contracted level as a result of COVID-19 disruption. Ramp up to full-rate production in 2021
- Governments of Italy and Sweden committed to working with the UK to develop next-generation combat air capability
- A further six Hawk aircraft assembled in Saudi Arabia were accepted and entered service in‑Kingdom
- The design and production readiness phase of the Hunter Class Frigate programme for the Royal Australian Navy continues to make good progress
Sale of Advanced Electronics Company to Saudi Arabian Military Industries completed in February 2021
Maritime
- The fourth Astute Class submarine, HMS Audacious, left our Barrow site in April to begin sea trials with the Royal Navy
- Construction of the first two Dreadnought Class submarines continues to advance
- The build phase of the River Class Offshore Patrol Vessel programme is now complete, with the fourth ship, HMS Tamar, handed over to the Royal Navy in March, and HMS Spey, the fifth and final ship, handed over in October
- Construction of the first two City Class Type 26 frigates for the Royal Navy continues to progress
- Acquisition of Techmodal, a UK data consultancy and digital services business, completed in August
- Announcement of a 15-year agreement with the UK Ministry of Defence to supply the Next Generation Munitions Solution between 2023 and 2037
- RBSL has secured its share of the Mechanised Infantry Vehicle Boxer programme
Electronic Systems
- Airborne Tactical Radios and Military Global Positioning System acquisitions completed, performing well and integrations are progressing
- F-35 electronic warfare systems for Lot 12 completed, surpassing cumulative programme deliveries of 800 electronic warfare systems as of year end
- Successful demonstration of APKWS® ground-launch capability
- Terminal High Altitude Area Defense (THAAD) seeker executing at full-rate production, and receipt of additional order to design and manufacture next-generation infrared seekers
- Continued classified work
- Demand in the commercial business lines of Controls & Avionics Solutions and Power & Propulsion Solutions has been negatively impacted by COVID-19
Platforms & Services (US)
- Delivery of the first production Armoured Multi-Purpose Vehicles took place in the second half; one of each of the five variants delivered by year end
- Amphibious Combat Vehicle programme moved to full-rate production phase after Initial Operational Capability declared
- Delivery of more than 50 production Bradley A4 vehicles
- New US Navy contract modifications totalling $114m (£83m) for Mk45 Mod 4 upgrades
- Initial deliveries of Virginia Payload Module tubes completed
- Ship Repair secured more than $1bn (£0.7bn) in US Navy maintenance and modernisation orders
- Ordnance Systems received $233m (£170m) in modernisation contracts
- Contracted to provide five 57Mk3 and ten 40Mk4 naval gun systems for the UK Royal Navy’s Type 31 frigates
- Operational delays and disruptions related to the COVID-19 pandemic were experienced across manufacturing and shipyard facilities
Cyber & Intelligence
Intelligence & Security
- US-based Intelligence & Security business continues to maintain its bid pipeline, perform on existing contracts and win new orders. All three businesses delivered a book to bill1 ratio of over one.
- Awarded a seven-year, $495m (£362m) contract on Instrumentation Range Support Programme
- Multi-year Indefinite Delivery, Indefinite Quantity contract received to provide electronic hardware and engineering services for a US government customer
- Our Federated Secure Cloud technology approach and processes are being employed to maintain and secure US Army Cyber Command’s virtual desktop infrastructure
Applied Intelligence
- Strong order intake, revenue and profitability performance in the core underlying business driven by the Government business unit
- Significant profit growth year-on-year due to cycling the restructuring of the Technology & Commercial business in 2019
Sale of the US-based software-as-a-service business completed in November
CHW (London – 25th February 2021)
Howard Wheeldon FRAeS
Wheeldon Strategic Advisory Ltd,
M: +44 7710 779785
Skype: chwheeldon
@AirSeaRescue