BAE Systems (LSE: BA) shares rose last week on new orders for the F-35 fighter jets that the company co-produces. The deal is part of Romania’s commitment to raising its defence spending to 2.5% of its gross domestic product this year. It comes in response to Russia’s invasion of Ukraine, with which Romania shares a 400-mile border.
It benefits from global insecurity
For me, the deal underlines that the invasion has changed the defence posture of the US and its allies for the foreseeable future and beyond. Last year, NATO governments pledged to increase their defence spending.
There are concerns over China’s ambitions regarding Taiwan, so US allies in Asia are boosting their defences too. And BAE Systems – the biggest defence contractor in Europe – should benefit from this global security uncertainty.
Huge order book and backlog
It has won many other huge contracts this year against this backdrop.
In January, it secured a new order for mortar systems from the Swedish Army, starting service in 2025. In February, it began construction of the third Dreadnought Class nuclear submarine, due to enter service in the early 2030s. And in March, it won a key role in the nuclear submarines to be provided to Australia.
In total, it has an order book worth £48.9bn and a backlog worth £58.9bn, according to the company’s 2022 results.
Key metrics improving from a high base
Elsewhere in the results, all the key numbers looked impressive to me and I’m bullish for the future. Revenue increased 8.9% year on year, exceeding consensus analyst estimates by 1.3%. Earnings per share (EPS) also beat analyst estimates – by 4.7%.
As a result of the stronger-than-expected numbers, the company increased the reward to shareholders. It bought back £788m of its shares and increased the annual dividend by 8%, from 25.1p to 27p per share.
Positive trends set to continue
This positive trend for BAE Systems is set to continue through 2023 and 2024. The company forecasts a 3%-5% increase in sales and a 5%-7% increase in underlying EPS for the year ahead. The projections for dividends in 2023 and 2024 are 28.9p and 31.1p per share, respectively. Its finance director, Brad Greve, anticipates further top-line growth and continued margin expansion in 2023 and beyond.
Positive as well for me is that government defence departments rarely cancel contracts. They also rarely quibble about rising costs linked to inflation and applied in existing contracts. And these factors mean that BAE Systems should be able to grow its business and maintain healthy profit margins.
The risk in these shares is that many environmental, social, and corporate governance (ESG) portfolios can’t hold defence stocks, which limits their appeal somewhat. And an easing of global tensions could also dent the share price.
However, for me, the geopolitical backdrop and BAE’s very positive financials outweigh these risks. After the recent bump in the share price, expect the shares to keep rising strongly. This is why I bought more of the stock recently.
