Given the potential £41bn final price tag, Monday night’s non-binding vote to continue developing a successor to the Vanguard class submarines that carry the UK’s at-sea nuclear deterrent will certainly have major implications for the largest domestic defence firms in the decades ahead.
The largest benefactor is likely to be BAE Systems (LSE: BA), the company that’s tasked with designing and building the submarines. In 2015, 37% of the BAE’s UK sales came from maritime contracts that totaled some £2.7bn for manufacturing everything from aircraft carriers to attack submarines. Therefore the successor programme is unlikely to move the needle significantly in the short term but will provide several decades of reliable revenue when designing, building and maintaining the fleet are included.
This steady revenue stream is incredibly important in as cyclical an industry as defence. BAE found this out over the past decade as defence spending cuts in the years after the Iraq War led to share prices more than halving from 2008 to 2011. Although share prices have now more than recovered, the stock is still trading at a relatively sedate 14 times forward earnings. Throw in a 3.9% yielding dividend and increased defence spending in each of its three main markets and you have a recipe for what could continue to be a long bull run for BAE.
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A bet on higher defence spending
Once built the new submarines will be based out of Faslane naval base, which is managed by support services firm Babcock International (LSE: BAB). Babcock runs several of the Navy’s major ports and looks set to benefit greatly in the coming years as the MoD is pushed to outsource servicing and training to private firms in order to save money.
As the single largest provider of support services to the Navy, Babcock will be salivating at the MoD’s latest Strategic Defence and Security Review which called for £62bn in naval spending on equipment and services in the coming decade alone. With 42% of revenue coming from UK defence spending, budget increases in the short term and the Trident programme in the long term could set the stage for many years of increased sales for this division. With shares trading at 9 times forward earnings and a 2.7% yielding dividend, the company could be an interesting bet on increased defence spending in the coming years.
Nuclear engines
Supporters of renewing Trident have long emphasised its benefits for the UK’s manufacturing sector and one company that would back this up is Rolls-Royce (LSE: RR). Although only 5% of Rolls’ 2015 revenue came from civilian and military nuclear contracts, the £510m in revenue from submarine engine design and servicing last year shows the potential benefits to Rolls of the successor programme.
This news couldn’t have come at a better time as the company embarks on a multi-year turnaround programme intended to halt the series of profit warnings that have sent shares tumbling over the past two years. While Trident alone won’t do much to improve the bottom line in the short term, management won’t scoff at several decades of healthy margins from designing, manufacturing and servicing the successor programme’s nuclear engines.
