Shrove Thursday
BAE Systems (LONDON:BAES)’ share price has risen c 14% year to date, largely on the back of emerging investor optimism that the US defense budget has started to rise again. But FY14 results, and guidance for 2015, suggest that the heavily US-focused Land & Armaments has yet to trough (2015, perhaps). And the broader guidance for “marginally higher” EPS is we believe, driven only by the combination of the lower share count and an unusually optimistic anticipation of new naval and air orders. In the (in our view more likely) outcome of such orders being delayed (and/or UK defence cuts post-Election), our forecasts put BAE on a remarkably flat 37-38p of earnings out to as far as 2018e. On 14.6x 2015e, we see the shares supported at these levels by the combined effects of the yield and buyback but, absent major export orders, with little to drive them higher.
FY14 results in line, but cash timing benefits
FY14 results were in line with our forecasts, save for a slightly lower than hoped for final dividend. There was a lot of noise in the divisional results, highlighting the high level of restructuring and ongoing challenges in BAE’s three US-focused divisions. Net debt, always a volatile number, was the one stand-out result, (£1,032m vs our forecast of £1,568m), with receipt of both new and early receipt of advances and progress payments at the end of the year.
2015 guidance: Central case or best case scenario?
The most striking thing about BAE’s guidance is the “reliance on anticipated naval and aircraft orders”. We believe this refers to Australia, where BAE needs to fill the post-LHD shipbuilding hole, and further Typhoon orders, most probably from Saudi Arabia. Both are possible: BAE’s relationships are good with each government. But we are very surprised that BAE should predicate 2015 guidance on them occurring within the next 10 months.
Dividend and capital allocation questions
We question whether BAE’s heart is really in the share buyback process. The £281m expended in 2014 (only £44m of which was in H2) is a glacial rate, only just sufficient to reduce the share count, and add a percent or two to EPS. With cover now well below 2.0x, we see BAE reaching near-term limits on dividend growth, and think that the buyback will become increasingly important for the shares.
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