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BAE SYSTEMS

BAE SYSTEMS – STEADY AS SHE GOES!
By Howard Wheeldon, FRAeS, Wheeldon Strategic Advisory Ltd.

01 Aug 13. Given the not insubstantial impact from US sequestration this year plus continuing adverse impacts from ongoing reductions in UK defence spending BAE Systems has in my view done very well to produce H1 results not that dissimilar to those of a year ago. 2013 was always going to be a period of serious adjustment for all those engaged in the defence industrial sector as will next year also be too. But for those that are already very well established internationally such as this one clearly is I firmly believe that whilst the effects of defence cuts from mature economies will continue to be felt this period should also be seen by investors as one of great opportunity for BAE Systems. As in the past the bias of strength will best be seen within second half results performance. I suspect that while underlying first half earnings are down 4% on sales that were very slightly ahead the short term take from H1 results would be to recognise that the company has, subject to Salam price escalation settlement, not only maintained its double digit underlying earnings growth outlook but that it has also raised the dividend a touch!

While UK and US activity has required significant adjustment over the past year the great strength of BAE Systems is portfolio diversity and the spread of activities internationally. It is this that I wish to mainly center my remarks today. This is a well managed company that has a long record of proven ability to quickly adapt when necessary. BAE has in recent years placed great emphasis on performance and on reducing a hitherto high risk profile. With a strong balance sheet, still decent margins, a £43.1bn order backlog BAE can move forward from a position of strength over the next year as it works hard to win a variety of truly excellent international contract opportunities.

Away from mature western market economies that have chosen to scale back on defence spend I believe that the outlook for BAE Systems really does remain excellent. In support of this argument I would first point to the additional £4.8bn of non-UK/US orders received during the H1 period. Additional orders from the Kingdom of Saudi Arabia (KSA) during the first half of the year come on top of a huge order from the Sultanate of Oman signed in December last year and the order from KSA for 22 new Hawk T2 aircraft.

Adding to the existing Khareef offshore patrol vessels currently under construction in the UK in December last year the Sultanate of Oman, another longstanding international BAE Systems customer, announced a landmark contract for the supply of twelve Typhoon and eight Hawk Advanced Jet Trainer aircraft along with in-service support for the Royal Air Force of Oman.

Within the H1 statement the company has reaffirmed that “a key feature of the anticipated trading profile across the second half of the year will be formalising the contractual price escalation obligations under the 2007 Salam Typhoon agreement with the Kingdom of Saudi Arabia”. Reaching agreement on outstanding Typhoon contractual issues within the price escalation negotiations on appropriate terms is crucial and the hope is that this can now be achieved during the second half period.
Typhoon deliveries to Saudi Arabia resumed earlier this year with four aircraft being delivered during the first half. These aircraft together with the initial phase of twenty-four Typhoon aircraft delivered between 2009 and 2011 take the total number of aircraft delivered from the order for seventy-two aircraft to twenty-eight and the company expects to deliver six further aircraft this year. For the record BAE tells us this morning that deliveries of Typhoon Tranche 2 aircraft to the four European partner nations including the UK totaled 15 during the period. At the end of June cumulative aircraft deliveries to the four nations was 184 from a contracted 236.

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