The BAE Systems (LSE: BA) share price has more than doubled from 24 February 2022 when Russia invaded Ukraine. In the last 12 months, which also marked the onset of the Israel-Hamas War on 7 October 2023, it has increased 40%.
Nobody, except those who start them, wants wars. But defence companies benefit from them, just as pharmaceutical companies do from disease and infirmity, which no-one wants either.
Additionally, much weapons spending is aimed at preventing wars through the deterrent effect of strong defence.
Defence budgets ballooning
Many governments in Western Europe believe that if Russia is successful in Ukraine, then it will continue to move westwards.
This is why in February, NATO members vowed to increase their defence spending to 2%+ of their gross domestic product.
The move followed US presidential hopeful Donald Trump’s comments that his administration would not protect NATO members that failed to meet that target.
Germany’s IFO Institute has calculated that €1.8trn must be spent to compensate for 30 years of under-investment in European defence.
Huge order book
Given this, a month rarely goes by without the announcement of some major new contract award to BAE Systems.
For example, 2 May saw it awarded an $87m contract by the US Navy for repair work on one of its ships. The day before saw it secure a contract for an undisclosed amount to develop two major satellite projects for NASA. And 24 April saw a confirmation that it will be a lead developer on the UK’s sixth-generation fighter, Tempest.
These add to BAE Systems’ already booming order book. This rose to £58bn in 2023 from £48.9bn in 2022. Over the same period, its order backlog jumped to £69.8bn from £58.9bn.
These drove sales of £25.3bn in 2023 (up from £23.3bn in 2022), and operating profit to £2.6bn (from £2.4bn). For 2024, it expects year-on-year increases in sales of 10%-12% and in underlying earnings of 11%-13%.
One risk to the stock is that the world becomes much safer, something we all hope for. Another is any major redesign of a core product line, which would be very costly.
However, consensus analysts’ forecasts are for earnings and revenue to increase 6.7% and 8.8% a year, respectively, to end-2026.
Earnings per share are expected to grow 7.1% a year to that point. And return on equity is projected to be 18.7% by then.
Is any value left in the shares?
Just because a stock has risen in price does not necessarily mean there is no value left in it. It may simply be that the company is worth more now than it was before.
In fact, it may be worth even more than the current share price reflects. I think this is the case with BAE Systems.
Even with its dramatic share price rise, it trades on the key price-to-earnings (P/E) ratio measurement of 22.3. This looks very undervalued against its peers, the average P/E of which is 44.1.
It also looks very undervalued on the price-to-book (P/B) ratio as well – trading at 3.9 against a peer group average of 4.6.
I already own the stock, but if I did not, I would buy it today for the undervaluation, and the strong growth prospects.
