James Gard: Welcome to Morningstar. Our latest stock of the week is BAE Systems, which has just put out annual results for 2022.
The defence company reported record orders for 2022 and a multi-billion pound backlog. The dividend is being increased too.
As we mark the first anniversary of Russia’s anniversary of Ukraine, investors assume that we’re living in a new world of global insecurity. And that means higher defence spending and higher orders for military hardware. That’s priced into BAE shares, which rose more than 50% last year, making them the best performers in the FTSE 100. This momentum has continued into 2023 with shares up 5% so far this year.
The bull case for BAE shares is that customer orders are mainly long term, spanning many years and providing visibility for revenue and earnings. Unlike companies, governments tend to spend money through thick and thin, resisting recession and inflation pressures as they deal with the biggest threats right now.
What are the risks? Defence stocks are excluded from many ESG portfolios, and that makes it hard for investment managers to own them. That pressure is likely to increase in the coming years.
A resolution in the Ukraine-Russia war, although that seems highly unlikely in February 2023, could shuffle military spending back down the list of priorities. European politicians could then start focusing again on the climate transition and how to meet those tricky net zero targets. UK defence spending anyway could shift focus away from military hardware like helicoptors, submarines and missilies – and more towards cyber security threats.
After the results, Morningstar analysts re-affirmed the fair value for BAE shares at seven pounds per share. They’re currently trading at over nine pounds a share.
For Morningstar, I’m James Gard.
