BAE SYSTEMS AND ROLLS-ROYCE – ADDING VALUE – ADAPTING TO CHANGE
By Howard Wheeldon, FRAeS, Wheeldon Strategic Advisory Ltd.
BAE Systems – Interim Results Comment:
Although coming in fractionally above analyst expectations BAE Systems first half results are in line with previous company guidance indicating that FY14 earnings would likely fall by between five and ten percent. Revenue for the first six month period was £7.6bn with underlying EBITDA of £802m against a figure of £867m for the previous year. With sales being heavily second half weighted, particularly in relation to deliveries of Typhoon, if one excludes the currency aspect the first half decline is not a particular concern. While currency translation impact is an ongoing concern excluding this factor BAE Systems remains comfortable that it is on track to deliver full year earnings in line with previous guidance.
With an order backlog just short of £40bn combined with expectations that further sizable international and domestic orders could potentially be added later this year the outlook period for BAE looks reassuring enough. From an operational point of view the company is performing well enough and with the considerable amount of export and international potential the hope is that the lull in growth will only be temporary.
Given the impact of UK and US defence cuts plus the level of repositioning that has been required in some of its traditional markets such as the UK and US BAE Systems does in my view look to be in a good position to move forward with increased confidence. Strong margin performance reflects considerable cost efficiency effort and, following combined dividend payments and share repurchases totalling £618m, cash flow remains strong. Net debt for the six month period end was relatively unchanged standing at £1.182bn.
This has been both a difficult but on the other hand very satisfactory period for BAE Systems. Various milestones have indeed been achieved on a variety of programmes not least the floating of the first of the two new carriers HMS Queen Elizabeth. The Typhoon programme has also made positive headway in terms of programme stability and in receiving commitment for additional capability development. While 12 Typhoons had been delivered in the first half of the year the second half will likely see as many as 30 aircraft delivered in H2. Note too that the build programme for the eight Hawk jets for Oman has also begun over the past month.
BAE Systems was also selected to provide integrated flight control electronics for the next-generation Boeing 777X and earlier this month the UK and French governments signed a joint commitment to develop a joint Future Combat Air System. Flight trials of the Taranis unmanned combat aerial vehicle continue successfully and a proposed bolt on acquisition of a US intelligence capability company was announced.
A good example of how BAE Systems has been adapting to market change is the growth seen in its Applied Intelligence business which has seen its order book rise by 25% this year following on from a 60% increase witnessed in the previous year. BAE Systems certainly cannot be accused of standing still and while the outlook for growth in defence is to an extent marred by lower UK and US activity the raised level of geo-political issues of late and the strong message that in capability terms NATO is too weak might suggest that the bottom of the defence cycle may soon be reached.
Rolls-Royce – Interim Results Comment
Interim results from Rolls-Royce announced were also perfectly in line with the FY14 flat revenue and profits guidance given by the company in March. A decline in profits from defence combined with weaker trading in Marine are primarily to blame but making matters worse was an adverse £21m hit from currency translation.
With high currency exposure I suspect that second half results are likely to be similarly impacted by the effects of adverse currency tran