Earnings: why BAE Systems shares remain at high altitude

BAE system (LSE: BAE) shares remain near all-time highs after the defense giant announced its first full year results. Almost a year to the day since Russia launched a full-scale invasion of Ukraine, BAE reported record order flow for 2022.

Defense stocks have risen about 50% over the past year, driven by the government’s increased military budget following the invasion. And as the battle continues, management is also guiding for a strong 2023.

As I write, shares are down just 0.8% at 897p.

Result

BAE is one of the largest arms producers in the world, manufacturing everything from Eurofighter Typhoon jets to nuclear submarines, tanks and howitzers. Beyond its diverse product offering – spanning land, air, sea, and cyber – the company is also geographically diversified. Customers are spread across the globe, mainly in the UK and the US, but also in the Middle East and Europe.

Western governments are committing more advanced weapons to the defense of Ukraine, and this will continue until there is some resolution to the conflict.

Buoyed by a strong US dollar – where BAE receives the bulk of its revenue – sales to the end of December 2022 rose 9% year-on-year to £23.3bn. On a constant currency basis, sales are up 4.4% over 2021. The group is growing in all business segments.

Underlying earnings per share increased by 9.5% to 55.5p, with growth again measured in constant currency. Free cash flow of £2bn exceeded expectations.

Develop an order book

These numbers may not seem so obvious due to the geopolitical background. But the company’s order book is growing rapidly. Last year, the group secured a record £37.1bn in new orders, increasing its order backlog to £58.9bn. The contract is for several years, providing a predictable stream of income and profits in the future.

The next dividend payment on shares is 7.6% to 27.27%. The dividend yield in 2018 is 3%. The payment is guaranteed twice with the base earnings.

Looking ahead to 2023, BAE expects underlying operating profit to grow in the range of 4% to 6%. And management is targeting free cash flow of £4bn to £5bn between 2023 and 2025. If it achieves that, and I see no reason to doubt that it will, the company looks well placed to continue increasing payouts.

Will I increase my stock?

The stock has a price-to-earnings (P/E) ratio of 20.7, which is above the average of the past few years. So it might be worth the risk to buy at the current price.

I just bought the stock a few months ago, and I like the size of the holding. So, I won’t be buying any more shares, because they still exist. However, if the stock price is going to drop in the coming weeks, I would consider topping it.

That is because, unfortunately, the genie is out of the bottle after the terrible events in Ukraine. Even if the expected cease-fire is announced, I still expect military budgets in Europe and elsewhere to increase rapidly. As Europe’s largest defense contractor, BAE sells the weapons countries need to protect themselves.