More on BAE Systems
BAE
BAE’s (the former British Aerospace) 2004 turnover was up 7.2% to £13.5bn and operating profit (before exceptionals and goodwill) was up 3.4% to £1.0bn. BAE designs, manufactures and supports military aircraft, surface ships, submarines, space systems, radars, avionics and a range of other defense products.
The customer solutions and support business (which provides services to the military) generated an operating profit of profit of £413m (40.2% of total,+0.5%) on a turnover of £2.2bn (+3.6%). Margins fell from 19.0% to 18.4%; continuing the negative trend since 2000 where margins were as high as 23%. Margins fell as BAE systems undertook more lower margin business from the UK, and shifted Al Yamamah business into Saudi Arabia. Margins are unlikely to recover, and BAE Systems expects the margins to hit the lowest levels in 2005. High oil prices helped improve cash flow to £1.0bn (2003 £518m). The order book increased by 11.5% to £2.9bn.
The commercial aerospace business generated 17.1% of the total operating profit (£176m, -13.7%), almost all of the profit accounted for by the 20% stake in Airbus. Margins fell from 7.0% to 6.1%. Airbus reports a rise in market share, but with pricing in US dollars medium term margins will be held back as the dollar weakens against the sterling. The weakening of the dollar and the expected weaker mix by Airbus in 2005 may mean that operating profit may not recover in spite of a 10% increase in deliveries (Airbus expects 2005 deliveries to be up 10% from 2004) Order book was down 2.3% to £20.9bn.
BAE’s North American business (which designs, develops and manufactures electronic systems for the defence industry) generated an operating profit of £233m (22.7% of total,+0.4%) on a turnover of £2.7bn (+2.6%). Margins weakened from 8.6% to 8.4%; well below the 9.9% margin in 2000. Weakening of the dollar reduces sales and operating profit by £334m and £25m respectively. Order book was up in dollar terms by 16.7% to US$4.9bn, but in sterling was up 4.2% to £2.5bn-reflecting the weakening of the dollar.
The share trades at a prospective PE of 11.2× (242.5p), is the lowest in the sector. The 4.1% yield is the highest for the sector. The rating reflects continued weakening of margins. Weakening of the dollar is a concern in the short term. The rating may also reflect BAE systems pension deficit: 43% of the current market value.
The free cash flow per share of 57p is much better than the 18p EPS. The upside to the stock in the short term stems from acquisitions, which should increase profits. BAE Systems spent £663m in cash in 2004 to fund acquisitions.
In 2004, the total forward order book improved from £46bn to £50.1bn more than three years worth of sales at current levels.
BAE Systems will acquire United Defense Industries, a US defence company for £2.2bn. In 2004, United Defense Industries had a turnover of £1.2bn, i.e, 9% of BAE System’s 2004 turnover. The acquisitions will be immediately earnings enhancing, with returns expected to exceed BAE’s cost of capital by 2007. This proposed acquisition increases BAE Systems’ exposure to the US defence market in the long term. In the short term, the acquisition will increase the exposure to the weakening of the dollar, however reported profits will increase. The shares issued to partially raise funds for the acquision amounts to 5% of the issued share capital. The balance will be funded by debt.
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