It’s difficult to begrudge the financial community for what has at times been quite a downbeat view of the future for BAE Systems (LSE: BA) when the sometimes-pessimistic communications between the management team and investors are taken into account.
But despite this, a quiet sense of contrarian optimism has been growing within me for some time now.
Already, rising tensions between Nato and Russia in Europe, as well as an increasingly fractured and conflicted Middle East, have gradually proven too much of an obstacle for the austerity ambitions of BAE’s two largest customers.
In November, a budget deal signed into law by the US government provided for the creation of an emergency war fund. One that increases US defence spending by $56bn over the next two years. The UK government announced a similar-but-lesser measure around the same time.
Yes, much of this is old news now and the shares have risen accordingly by just over 10% since the announcements. But there have been several events over the last week that have provided further encouragement to my budding sense of optimism when it comes to BAE shares.
Hostilities are growing between Iran and Saudi Arabia
Saudi Arabia is BAE’s third-largest customer. Rumour has held for a long time that the kingdom is heavily invested in the Syrian civil war, diplomatically and monetarily, while more recently it has played a key role in a military coalition that’s fighting in Yemen.
That conflict is already reported to have cost as many as 6,000 civilian lives and up to 2,000 Saudi soldiers.
The same rumour mill has placed Iran at the centre of each conflict in Syria, Iraq and Yemen, albeit by virtue of proxy forces.
The plot thickened at the weekend when the world awoke to news that Saudi Arabia had executed a total of 47 people, including a prominent Shi’ite cleric, which drew an instant rebuke from Iran.
The last 24 hours saw Iran issue a barely-veiled threat to Saudi Arabia when it paraded a number of long-range ballistic missiles around on national television, from an underground bunker.
The upshot
Clearly, the world remains a hotbed of tensions and conflict in 2016, much of which involves either one or all of BAE’s top three customers. While negotiation is always the best way forward, these tensions could prove a boon for Britain’s largest defence company.
Regardless of whether or not hostilities escalate further between Iran and Saudi Arabia, the very presence of rising tensions will probably serve to protect Saudi defence spending throughout the current downturn in oil prices. It could even serve to increase it.
Either way, my growing sense of optimism about BAE’s prospects remains alive and undeterred as it’s increasingly looking as if austerity in defence spending is over for the world’s largest military powers.
I’m further encouraged that some brokers appear to share this same view, which was evidenced this week by the RBC Capital Markets decision to rate BAE as its Top Pick, before assigning a price target that implies a 26% upside to the shares.
