Amid a period of important management and organisational streamlining announced last year and that has seen BAE Systems realign and reposition itself for what to me looks to be a far more positive medium and longer term outlook, the company has also once again been able to deliver another excellent set of full year results for 2017.
BAE Systems management clearly views the medium and long term growth outlook as being excellent and while the flat earnings performance anticipated for the current year reflect a number of timing and other issues, the decision to reposition itself last year and for what most agree as being improving market conditions and outlook, presents a strong basis on which I believe this company can now look forward to a very interesting and rewarding future.
Significant organisational changes which had been announced in the autumn of last year and that came into effect on January 1st 2018 had no impact on BAE Systems performance last year. Without changing an underlying financial strategy that has worked so well for BAE Systems over many years, it is good to see new CEO, Charles Woodburn, confirming a forward strategy intended to focus on programme execution, technology and enhanced competitiveness in the years ahead. This together with being very well invested to meet future anticipated demands can be expected to provide a very solid foundation for medium and longer-term growth.
Clearly there have been disappointments over the past year particularly those relating to the Applied Intelligence division and where a large provision was taken. And with the current year also being seen as a year of transition and change as some of the older Typhoon customer production programmes draw to a close before more recent export awards for Typhoon begin to ramp up and as the maritime activities once again begin to ramp-up, I suspect that the fall in the share price this morning is most likely based on company guidance for 2018 earnings being generally flat.
Even so and as already mentioned, the medium and longer term outlook for BAE Systems is, in my view, demonstrably strong. Indeed, looking beyond the short term earnings outlook guidance presents a very different perspective of positive opportunity. Very well managed, reorganised and where it now needs to be, BAE Systems is in my view superbly positioned to benefit from a positive changes that are occurring in defence budgets and also from a strategy of investing in its own future.
In respect of FY17 performance, revenue increased by £0.6 billon to £19.6 billion and underlying Earnings Before Interest Tax and Amortisation (EBITA) increased by 4% to £2.034 million. Underlying earnings per share increased by 8% to 43.5p and importantly, operating cash flow increased by £748 million to £1,752 million, net cash flow increased from by £668 million to £1,897 million and net debt declined by £790 million to £752 million. The annual dividend of 21.8p, a 2% increase on FY16, marked the fourteenth year in succession that the dividend had been raised and importantly, the group’s share of the net pension deficit declined from £6.1 billion in FY16 to £3.9 billion at the end of 2017.
The preliminary results confirm that order intake in FY17 was just over £20 billion and that the year-end order backlog stood at £41.2 billion, broadly similar to last year. Whilst formal guidance for the current year is for earnings to be broadly similar to FY17 the medium and longer term outlook remains very positive.
As seen from the announced defence budget increases in the US, Germany and France and the increased level of defence expenditure by many states in the Gulf Region, following years of cuts there appears to be an almost universal reversal in the attitudes and recognition by many nations of the need to spend more on defence. The industry as a whole will benefit but BAE Systems is, in my view, very well placed to be a major beneficiary of this in the various nations that it operates. Export opportunities have undoubtedly increased and as Charles Woodburn said earlier this morning, “the opportunity book for Typhoon is as good as I’ve seen it in the last two years and probably as good as it’s been in quite some time”.
I share the above view and would add that although BAE Systems was able to announce a £5 billion deal to supply 24 Typhoon aircraft to Qatar in December last year. No part of this has been included in the above FY17 order receipt figures and, subject to receipt of first payment which is anticipated no later than mid-2018, it will be added into the current year figure.
Apart from being engaged on various other international Typhoon campaigns BAE Systems has emphasised the growing strength of its US-based Electronic Systems business and, driven by a number of electronic warfare contracts, has pointed toward high single digit sales growth for 2018. Worth noting too that the company received significant additional orders on the F-35 Lightning II programme last year covering both hardware and support worth $450 million and that it sees growing demand emerging for its Advanced Precision Kill Weapons System laser-guided rockets for which awards last year were worth $300 million.
In respect of Platforms and Services in the US sales growth in the region of 10% to 15% is anticipated reflecting an increase in volumes of US Combat Vehicles and Weapons System businesses along with higher ship repair activities. During the past year BAE Systems received a £306 million contract for the final option for Low Rate Initial Production of 48 M109A7 self- propelled howitzers together with options for a further 180 vehicle sets.
In respect of Air, with Typhoon deliveries for the UK, Germany, Spain and Italy largely complete along with those ordered previously by Saudi Arabia and Oman 2018 can be anticipated as a year of transition ahead of increased export related activity. BAE Systems is a significant beneficiary of the order from Kuwait for 28 Eurofighter Typhoon aircraft that was announced by Leonardo in 2016 and will over the next few years benefit also from the Qatar order for 24 Typhoon aircraft.
BAE Systems Maritime activities also find themselves in a period of transition as level of activity on the two Queen Elizabeth class aircraft carriers, one of which has already been handed over to the Royal Navy and commissioned, reduce and before Type 26 activity of which the first three of an intended eight ships have been contracted at a value of £3.7 billion, ramps up.
FY17 results show that Applied Intelligence reported an underlying loss of £61 million, a figure that includes a £24 million restructuring charge. A goodwill impairment charge of £384 million was also taken in FY17 marking the completion of significant restructuring of these activities. Cyber and Intelligence activities are now anticipated to show some improvement in 2018 with growth occurring in the Applied Intelligence activities although sales of Intelligence and Security are expected to be largely flat.
The appointment of Nigel Whitehead, previously Group Managing Director of Programmes and support as the Chief Technology Officer for the company from January 1st this year provides ample demonstration of the intention to seek out and develop technology and to make this work to the company’s advantage. BAE Systems already invest heavily in research and development and last year was no exception. The appointment of such a highly respected individual and who knows well what BAE Systems is capable of achieving is one that should not be ignored in weighing longer term opportunities and reward.
CHW (London – 22nd February 2018)
Howard Wheeldon FRAeS
Wheeldon Strategic Advisory Ltd,
M: +44 7710 779785