Could BAE shares benefit from tensions in the Ukraine?

With the Western world waiting with baited breath to see what the Russians will do in the Ukraine, now could be a good time to look again at BAE Systems PLC. The Russian Federation has amassed 100,000 troops on the Ukrainian border and, despite President Vladimir Putin’s insistence that the state has no intention of invading, an invasion could be imminent. With the US planning to instigate the “mother of all sanctions” if it does, shares in the British defence contractor look likely to benefit.

The shares trading strongly in January, hitting a high of 608p, but at 572p have fallen back 6% on profit-taking. They are also one of the top dividend payers in the FTSE100, offering a 4% yield. In tough financial times, defence stocks can also offer a safe haven as they can be less subject to economic headwinds and the ravages of inflation.

Fighting fit

BAE full-year results are due out on 24th February. The company has recently announced a handful of contract wins and updates, including winning a $169m production contract from the US Marine Corps to supply its amphibious combat vehicles and a $14 million radio communications contract from the US Intelligence Advanced Research Projects Activity (IARPA) to develop tools to decipher radio frequency (RF) signals. It also recent hit key production milestones in its deal with Lockheed Martin to supply the vehicle management computer (VMS) and active inceptor systems (AIS) for the F-35 jet, delivering its 3,000th VMC and 1,000th AIS.

In addition, BAE has submitted a bid with the Swedish Defence Materiel Administration to supply its CV90 infantry fight vehicles to the Slovak Republic.

Robust pipeline

"Demand for our capabilities remains high and we have a strong pipeline of opportunities across our broad geographic portfolio that will enable our skilled, global workforce to deliver capabilities which will support our customers in responding to the evolving threat environment,” chief executive Charles Woodburn told investors at the trading update in November.

The pipeline includes providing life-cycle sustainment and technical support to the Limited Interim Missile Warning System program – worth up to $872m over 10 years – a five-year deal to provide Systems engineering and integration support services to the US Navy – worth up to $478m – and two Typhoon contracts with the British government worth a total of £355m.

West hikes defence spending

BAE said in its trading statement that it has a strong pipeline of contracts and that most of the countries in which it operates are increasing defence spending to “counter evolving threat environments.” This includes the US, which voted last year to increase its defence budget to $740bn a year from $715bn, Australia, France and Germany.

Deutsche Bank recently rated the shares a buy, setting a price target of 670p.

The downside with defence firms is that projects can often be hit by delays as they are reliant on the slow-moving bureaucracy of government spending decisions and can be affected by technology issues. BAE also depends on three main customers – the US, British and Saudi Arabian governments – for the majority of its revenues and cash-flow can be lumpy. However, with a decent pipeline of contracts, positive earning guidance for the full-year results of an increase in EBIT (earnings before interest and tax) of 6-8% and strong cash-flow generation – a portion of which will be returned to shareholders – the shares look a solid buy.

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