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BAE Systems (OTCPK:BAESY) is the largest defense contractor in the United Kingdom and is also one of the largest in the US. Hit by budget cuts in the US and UK, BAE Systems restructured its business and the first results are showing.

BAE Systems originates from the merger of General Electric's (GE) electronics and shipbuilding subsidiary Marconi and British Aerospace in 1997. In 2000 Control Systems and Aerospace Electronic Systems were acquired from Lockheed Martin (LMT).

Reduced activity to deployed forces in Iraq and Afghanistan and reduced defense spending by both the US and UK forced BAE Systems to start drastic reorganization and divesting activities. The participation in Saab AB (OTC:SAABF) was sold and the organization was changed from a functional to a more geographical structure to organize BAE Systems' activities.

This article is part of a series on the aerospace industry. Lockheed Martin and Northrop Grumman (NOC) are also primarily focused on the military market and are compared here.

FUNDAMENTALS1

Corporate20122011201020092008
Revenue$26,592$28,432$33,568$32,598$26,674
Net income$1,726$216$1,730-$98$2,829
EBIT$2,986$2,910$3,189$2,003$3,144
EBIT%11.23%10.24%9.50%6.15%11.79%
FCF$3,018$342$968$1,826$1,578
EPS$0.52$0.59$0.48-$0.03$0.79
Dividend$0.31$0.30$0.28$0.26$0.23
Dividend Yield4.46%
ROA4.84%0.58%4.50%-0.24%6.89%
ROCE13.97%14.18%16.11%9.38%13.20%
ROE28.59%3.14%20.01%-1.31%24.26%
Debt/Equity4.904.373.454.472.52
PE (Price/Earnings)13.34
  • Revenue is declining;
  • Net income is getting better;
  • EBIT is stable and profitability is increasing;
  • High dividend and increasing over time.

(click to enlarge)

BAE Systems has the following structure:

Electronic Systems: produces advanced technological systems and provides services, with the main focus on defense.

Electronic Systems201220112010
Revenue$4,011$4,232$4,750
EBIT$531$594$718
EBIT%13.24%14.03%15.12%

Electronic Systems can be compared to Northrop Grumman's electronic systems division. Northrop Grumman is larger, with higher profitability, but both have declining revenues and profitability.

(click to enlarge)

Cyber and Intelligence: provides government and commercial cybersecurity services.

Cyber & Intelligence201220112010
Revenue$2,243$2,238$1,922
EBIT$77$115$110
EBIT%3.42%5.15%5.75%

Profitability is marginal. This is partly caused because it is an asset-light activity with lower margins.

Platforms and Services (US): is composed of various activities such as:

  • Land and armaments division;
  • Ship repair for the US Navy;
  • Advanced ammunition facilities in the US;
  • Support on fixed-wing and rotary aircraft in the US.
P&S US201220112010
Revenue$7,152$8,408$12,206
EBIT$514$410$648
EBIT%7.18%4.87%5.31%

Revenue is declining sharply.

Platforms and Services (UK): Has several UK based activities such as:

  • Eurofighter Typhoon production;
  • Lockheed Martin F-35 Joint Strike Fighter program;
  • Shipbuilding for the Royal Navy, such as new aircraft carriers;
  • UK based armored vehicle production and support.
P&S UK201220112010
Revenue$8,899$9,850$10,277
EBIT$1,058$947$653
EBIT%11.88%9.62%6.35%

Platforms And Services (International): Composed of business and services in especially Saudi Arabia, India and Australia.

The participation in MBDA Missile Systems, the main competitor of Raytheon (RTN), is also part, but is a Joint Venture with Airbus (OTCPK:EADSF)(OTCPK:EADSY) and Finmeccanica (OTCPK:FINMF)(OTCPK:FINMY).

P&S International201220112010
Revenue$5,186$4,408$5,301
EBIT$654$702$667
EBIT%12.62%15.93%12.59%

Platforms and Services (International) is one of the growing and most profitable divisions of BAE Systems. In 2012 the order book has grown more than 100%.

(click to enlarge)

FUTURE

BAE Systems defines five home markets on which it operates:

  • US
  • UK
  • Saudi Arabia
  • India
  • Australia

The top four rank among the eight largest defense budgets in the world. BAE Systems has been able to increase revenue outside the US and UK. This is not visible in this chart, but the order intake has increased significantly and this will become visible over the next few years.

The economy of the United Kingdom is also recovering strongly and higher defense spending can be expected over the next few years.

INVESTING

With a PE of 13 BAE Systems is not expensive and has about the same PE as its US competitors Lockheed Martin and Northrop Grumman. BAE Systems' dividend is much higher.

The dependence on the US and UK will become less over the years. BAE Systems is the only defense manufacturer researched so far that has been able to increase revenue significantly in the rest of the world, although this is not yet visible in the results.

On February 20 BAE Systems will present its FY 2013 results. According to the outlook for 2013 - which were repeated in the 2013Q3 interim statement - 2013 will be slightly less or equal to 2012. BAE Systems however is also impacted by the US Government shutdown. Cost cuts will probably retain profitability.

If BAE Systems' share price drops a bit after the FY2013 results this is a good entry point for a stock with:

  • high and growing dividend;
  • potential for growth of revenue and profit over the next years.

Footnote

1. All financial data used is reported by BAE Systems.

  • The stock price used is USD 7.0 / GBP 4.375;
  • Exchange rate used USD/GBP 1.60;
  • All charts are produced using data published by companies in reports such as Annual Reports or 10-Ks.
Source: BAE Systems: Competition For Lockheed Martin And Northrop Grumman