Political interference led to the failure of the proposed $45bn merger of BAE Systems (LSE: BA) (NASDAQOTH: BAESY.US) and Airbus manufacturer EADS last year, but so far, there are no signs that BAE or its shareholders have suffered from the experience.
BAE’s share price has risen by 39% since the merger was abandoned last October, but the firm’s 4.4% yield and strong first-half results suggest that it remains an attractive buy, despite these gains.
Defence spending ‘stable’
BAE was expected to suffer under spending cuts linked to western austerity measures, but so far, these cuts have been less severe than expected. Earlier this year, BAE described the outlook for its UK defence business as ‘stable’, and said that it expected to deliver double-digit growth in underlying earnings this year.
In the first half of 2013, BAE’s earnings per share were broadly flat compared to the same period last year, but its order backlog edged up from £42.4bn at the end of 2012 to £43.1bn.
To anticipate possible US spending cuts, the firm has increased its focus on non-UK and US markets, and logged £4.8bn of new orders from these areas in the first half of this year alone.
Those Saudi Typhoons
Perhaps the biggest single question mark in BAE’s 2013/14 outlook is the continued delay in its renegotiation of the Salam Typhoon contact — a 72-plane deal to sell Typhoons to the Royal Saudi Air Force, which was signed in 2007, but has yet to be completed, due to ongoing price negotiations.
Aircraft deliveries restarted in April, and 10 aircraft are expected to be delivered this year, taking the total to 34. Failure to conclude these negotiations in 2013 may mean that the firm’s current £1bn share buyback programme is cut short, but the recent signature of a £1.8bn follow-on support contract for the Saudi Typhoons suggests to me that an agreement will be reached. This could trigger further gains for the shares, and would generate valuable cash flow for BAE.
Defensive value
City analysts currently expect BAE to deliver underlying earnings per share of around 43p this year, placing the firm on a forecast P/E of just 10.4, compared to 14.1 for the FTSE 100.
So far, BAE is on-track to deliver these results. Its underlying earnings for the last twelve months are 37.7p, placing it on an attractive trailing P/E of 11.8, with a prospective yield of 4.5%.
Buying opportunity?
BAE’s modest valuation and 4.5% yield make it a buy for me, and it’s worth noting that the firm is also one of the eight largest holdings of top UK fund manager Neil Woodford.
Mr. Woodford’s funds have delivered outstanding returns for his investors — if you’d invested £10,000 into Mr Woodford’s High Income fund in 1988, it would have been worth £193,000 at the end of 2012 — a 1,830% increase!
For access to an exclusive Fool report about all eight of Neil Woodford’s largest holdings, just click here. The report is free, but availability is limited.
> Roland owns shares in BAE Systems but does not own shares in any of the other companies mentioned in this article.
