Shares in FTSE 100 defence specialist BAE Systems (LSE: BA) have had a good run so far this year, rising from 565p to 635p. That represents a gain of about 12%, which is a decent performance when you consider the FTSE 100 index is down about 1% for the year.
There are two main reasons the stock has outperformed. Firstly, the defence sector has received a boost from the tension between the US and Iran. Secondly, the market liked the company’s announcement on 20 January that it plans to acquire both Collins Aerospace’s Military Global Positioning System business and Raytheon’s Airborne Tactical Radios business for a total of around $2.2bn.
‘Unique opportunity’
BAE says the acquisitions represent a “unique opportunity” to purchase high-quality, technology-based businesses with “market-leading capabilities” and “strong growth outlooks.”
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Can the shares keep rising after a 12% gain year to date? I believe they can, as the stock remains undervalued, in my opinion. And, looking at broker research, I’m not the only one who sees the potential for further share price gains here.
Multiple price target increases
Indeed, since the beginning of the year, a number of brokers, including Citigroup, Bank of America Global Research, and JP Morgan, have increased their share price targets for BAE Systems. Of the three brokers, JP Morgan has set the highest price target – 730p. That’s roughly 15% higher than the current share price of 635p.
Upside potential
Crunching the numbers, I believe a share price of 730p is certainly achievable for BAE. Currently, the consensus earnings per share forecast for the year ending 31 December 2020 is 48p. Therefore, a share price of 730p would equate to a forward-looking P/E ratio of approximately 15.2, which is only slightly above the median FTSE 100 forward-looking P/E ratio of 15.1.
Given the fact that BAE has quite a bit of momentum right now (it has recently signed a number of large contracts with defence agencies including a $2.68bn contract with the US Navy to supply laser-guided rockets) and is a reliable dividend payer (15 consecutive dividend increases) with a near-4% yield and defensive characteristics, I have no problem with that kind of valuation at all.
Favourable outlook
Of course, I’ll point out there’s no guarantee that BAE Systems’ share price will hit 730p in the near future. The FTSE 100 stock had a great run last year, rising about 23%, and it’s now up over 40% since its lows in December 2018. There’s always a chance it could experience a correction after such a strong run. The stock could also be impacted by a wider market pullback.
However, in my view, the outlook for BAE remains favourable. If JP Morgan’s 730p share price target is on the money, you could be looking at a very solid return on your capital when you consider that the stock also has a healthy dividend yield.
