BAE SYSTEMS – STRENGTH, DEPTH AND DIVERSITY
By Howard Wheeldon, Senior Strategist at BGC Partners

29 Apr 10. Europe’s largest defence player has delivered yet another set of excellent numbers showing headline half year sales up 9% and underlying earnings per share increased by 14%. Stockholders are once again rewarded with a pretty decent 9% increase in dividend. While there was a net cash outflow in the H1 period we expect to see this reversed during the second half. In summary and particularly given the excellent outlook statement we believe that BAE Systems remains well placed to provide sustainable growth.

With seven ‘home markets’ we believe that BAE Systems is now one of the best placed global defence industry suppliers. Understandably, the ongoing UK Strategic Defence and Security Review process together with the probability that US defense spending may soon begin to level off has led markets to take a more sanguine view on the outlook for certain defense primes. However, whilst BAE Systems cannot enjoy specific protection from mature western government based defence cuts we believe that the process and strategy of having seven international home markets developed by BAE together with the renewed emphasis on service and through life product support provides ample scope for the company to provide excellent growth in the years to come. It is probably worth noting two things in this debate 1.) that there are just as many countries increasing defence spending as there are those proposing to cut it and 2.) that each time western nations have cut defence expenditure not only have they have regretted it but have needed to spend more to catch up.

Currently the UK accounts for around 20% of BAE revenue and North America around 50%. Eighteen months ago India was added to that of Saudi Arabia, Australia, Sweden and South Africa in the ‘home market’ category. To that end we are now seeing dividends of a growing partnership in India – one that began with the first batch of BAE Hawk aircraft most of which have been built in India. Now another 57 aircraft are to be manufactured in-country with a significant amount of component supplied from BAE in the UK. Similar partnering arrangements with local companies in Saudi Arabia have emerged in recent years as part of the Saudiisation program and we suspect that we will see more in due course.

In terms of mainstream programs with high levels of work on the Lockheed Martin F-35 Joint Strike Fighter in which BAE Systems is a partner, with the export potential for Eurofighter Typhoon growing in our view as opposed to contracting on the back of immediate fears of defence cuts in Europe and a if our view that both carriers in the CVF program will be built, continuing Type 45 and Astute program work plus the ultimate potential of the proposed Type 26 in terms of this perhaps being an export led program we are comfortable that the mid term outlook on large programs remains good.

Clearly the failure to win certain awards in the US and the general dampening of expectations for land systems over the past year – not helped here in the UK by the seemingly ridiculous decision of the last government to award the initial FRES based development program to General Dynamics – means that we should probably expect land systems to experience weakness further out. However we note the renewed emphasis by BAE on security and consider that the potential to further develop these activities is enormous.

The strength of BAE Systems is not only the company geography, product diverseness and manufacturing efficiency it is the speed at which this company adapts. A truly global business and one in which the principle of ‘home markets’ should stand the company in very good stead through an otherwise difficult period ahead.
On 29 July 2010 – BAE Systems announced Half Year Results for 2010:
Robust and resilient global business is well positioned for long term growth

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