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BAE Systems poised to gain from growing defence budgets

A fighter jet

Military equipment manufacturer BAE Systems [BA.L] has seen a surge in business since Russian forces invaded Ukraine in February. With the UK’s biggest defence company expected to announce a trading update before markets open on Tuesday 15 November, it could be set to release another bumper quarter of order volumes.

BAE Systems had noted during its last financial update that defence spending was set to soar globally. In the UK, defence secretary Ben Wallace expects it to double by 2030 to 3% of GDP. US defence spending also looks set to rise, with a recent increase in its order volumes of BAE manufactured M113 armoured multi-purpose vehicles (AMPV) to replace the 200 sent to Ukraine, according to Army Technology.

Both the UK and US account for around three quarters of BAE Systems’ business. In the first half of 2022, BAE Systems’ order intake increased 70% year-on-year to £17.9bn, which was not far off its full-year total of £21.4bn for 2021.

Both sales and earnings also grew, jumping 11.8% and 5% year-on-year to £24.5 per share, and £10.5bn, respectively. However, free cashflow fell from £461m to £123m, with net debt also increasing to £3.1bn. Guidance for the full year remained unchanged, with sales forecasted to increase between 2% and4%.

BAE Systems stock outpaces FTSE 100

The increase in demand has seen BAE Systems’ share price gain 46% so far this year (through to 10 November), outperforming the FTSE 100’s 0.2% decline over the same period. The stock has become the blue-chip index’s fifth-strongest performer of the last 12 months, with gains of 40.6% over the period.

However, since 3 November the stock has been in a slight downtrend, falling 5.6% as of 10 November. The downward momentum began after it had announced securing £80m in avionic support contracts for the Eurofighter Typhoon aircraft. Despite reaffirming that it would continue to service and support the Typhoon aircrafts for the German, Spanish, British and Italian air forces for the next five years, it hasn’t helped to stop the fall.

Michael Kramer, founder of Mott Capital Management, believes that its share price reversal could be the start of something more “severe”. He said: “The technical pattern looks like a bull flag, but since the flag portion is rising, it’s not a bull flag. This is a reversal pattern. The stock has already broken lower, suggesting further declines could be on the way,” he told CMC Markets.  

Considering that its uptrend has been broken, Kramer believes this could result in the BAE Systems share price falling to around 684p – the stock closed at 777p on 10 November, and fell further, to 714p, by the close on Friday 11 November.

“Ultimately, the stock may even end up retracing and dropping to 611p. Additionally, the relative strength index has been steadily declining in recent weeks, and when coupled with the rising stock it creates a bearish divergence. This further indicates that the stock is likely to decline more in the weeks ahead,” Kramer added.

Analysts raise price targets ahead of earnings

Analysts are relatively bullish about BAE Systems’ prospects. Redburn analyst Oliveir Brochet rated BAE Systems stock a ‘buy’ on 7 November, according to Investing Reviews. The analyst said that the company was “leading income equity” within the aerospace and defence sector. On the same day, JPMorgan reiterated an ‘overweight’ rating for the stock, and increased its price target from 1,000p to 1,100p.

Among the 20 analysts polled by the Financial Times, four rate the stock a ‘buy’, seven ‘outperform’, eight ‘hold’, with one giving it an ‘underperform’ rating. Out of the 14 analysts offering 12-month price targets, the median target of 880p represents a gain of 23.25% over the coming year.

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