Profit from a rare British manufacturing success story
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Associate Editor
David Stevenson Feb 20, 2009
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BAE's Eurofighter Typhoon
There aren't too many British success stories around these days – certainly not in the financial world.
So when a major British company outperforms the market in style, then announces almost doubled profits and a nicely upbeat forecast, it's time to sit up and take notice.
The good news is that despite a superb set of results, this company still looks cheap.
But ethical investors might want to look away now…
The British company that's defying the recession
There's plenty of talk right now about how Britain's problems are down to us not making anything anymore. But that's not strictly true. It may not be something to feel particularly proud of, but the most recent statistics show there's one area at which we excel – weaponry.
Britain is the world's biggest arms dealer. In 2007 our weapons exports climbed to £10bn, a third of the global total. How have we done it? The swing factor on our hitting the top spot was a single huge deal, a £4.4bn sale of 72 Typhoon aircraft to the Saudis. And that wouldn't have happened without Britain's key player in the arms business – BAE Systems (LSE: BA).
The group is now Europe's biggest defence company, and the world's third-largest. Yesterday it stunned the market with the news that full-year profits for 2008 had nearly doubled, to £1.75bn, on the back of an 18% sales increase. That's well over a third higher than the £1.28bn that the City was expecting.
More 'good growth' is expected this year
And BAE expects more "good growth" this year. The order book has grown by 20% to £46.5bn, well over three times its stock market value. The company is now the fifth-biggest defence supplier in the States. It's won more contracts than US rival General Dynamics from the Pentagon for Mine-Resistant, Ambush-Protected vehicles for Iraq. In fact, it now sells more kit to the US Department of Defense than to the UK Ministry of Defence. And it reckons it will keep on cashing in on the ongoing weakness of the pound against the US dollar.
That's no mean feat - despite sterling's slide over the last six months, BAE remains one of the few really big British export success stories. The CBI reported this week that overall UK export orders continued to drop in February, and that more firms' order books were below normal levels than at any time since January 1992.
Controversy over the arms business hasn't hurt BAE's share price
So there's real demand out there for BAE's products. And that demand is likely to continue. Understandably, many people don't feel at all comfortable about the idea of investing in a company that makes weapons. Not only are there the issues about selling arms to the Saudis and the Americans, there are the wars in Afghanistan and Iraq.
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But regardless of your take on the wrongs and rights of these wars, someone has to supply our armed forces with the necessary equipment, whether armoured vehicles, battlefield radios or bulletproof vests. If it wasn't BAE, then it would be someone else, probably an overseas firm.
And at a time when jobs are being slashed around the world, BAE is a major provider of employment. It employs over 100,000 people globally, over a third of whom work in the UK. And Oxford Economics calculated that in 2006, twice as many jobs again were created in Britain by BAE's outsourcing of services.
Any controversy over what the group does – not to mention a few scandals – certainly hasn't hurt its share price performance in recent years. Over the last five years the stock has more than doubled in price while the FTSE All-Share index has dropped, on balance, by just over 10%. Yet despite that, and even although the share price has jumped by 3% since its strong results, BAE is now selling on a historic price to earnings ratio (PER) of just over ten times.
And by the time analysts have finished revising their forecasts for this year and next, earnings estimates are bound to get a good boost. That means the stock is likely to end up on a current year PER of below nine, with a prospective yield of 4%. That makes BAE look very cheap.
Whether you feel comfortable with buying the stock is of course, up to you. But in pure investment terms, defence is a – well, defensive sector, and BAE looks like a cheap way to play it. In this kind of investment climate, you can't really ask for more.
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