UPDATE: BAE Systems’ share price has dropped a staggering 15% as markets react to potential peace talks over Ukraine. However, analysts believe the market is overlooking a crucial factor that could lead to a significant rebound.
The key point? NATO has committed to more than doubled defense spending, regardless of any peace agreement in Ukraine. This shift is a structural change aimed at creating a long-term deterrent against future threats, not merely a temporary wartime spike.
Last June, non-US NATO members agreed to elevate defense budgets to 5% of GDP by 2035, a substantial increase from 2% last year. This translates into an additional $423 billion in annual spending across NATO nations, positioning BAE Systems, Europe’s largest defense contractor, at the forefront of this investment cycle.
Despite this backdrop, BAE’s stock is mispriced. The market is treating the company as if it faces imminent revenue declines, when in reality, its contracts are long-term and legally binding. The disconnect between market perception and actual earnings potential offers investors a unique opportunity.
Recent results highlight BAE’s strong momentum. In its July 30 half-year report, the company reported sales of £14.6 billion, an increase of 11% year-on-year. Earnings before interest and tax (EBIT) rose 13% to £1.55 billion, with basic earnings per share climbing 11% to 34.7p. The order intake reached £13.2 billion, contributing to a record backlog of £75.4 billion.
Given this robust performance, management has upgraded its full-year sales guidance to 8%-10% from 7%-9% and increased EBIT projections to 9%-11% from 8%-10%.
However, analysts warn that any issues with key products could impact future growth. Yet, projections indicate that BAE Systems’ earnings are expected to grow by 11.2% annually through 2028.
Despite these positive indicators, BAE’s stock trades at a forward price-to-earnings ratio of 23.5, down from 28.5 in June. This valuation does not align with the company’s long-term contracted revenue and expected double-digit earnings growth. A discounted cash flow analysis suggests shares are currently 28% undervalued at £17.50, with a fair value estimated at £24.31.
As the defense sector prepares for a decade-long rearmament cycle, BAE Systems is poised for growth, making it an attractive investment opportunity. With the fundamentals indicating sustained acceleration in earnings, the gap between market perception and reality could lead to substantial gains for investors.
Next Steps: Investors are encouraged to monitor BAE’s performance closely, as the company is likely to see increased interest from both analysts and investors in the coming months. The anticipated growth through 2026 could make this a pivotal moment for BAE Systems.
Stay tuned for the latest updates on this developing story.
