Government Spending Cuts And Rising Costs Will Undermine Revenues

Key Takeaways

• Shifting defense budgets, increased ESG scrutiny, and procurement localization threaten revenue stability, financing access, and international market opportunities.
  
• Heavy dependence on major government contracts and technology adaptation risks leave earnings exposed to contract changes and competitive disruption.
  
• Strong global defense demand, innovation in next-gen tech, and diversified geographic exposure are driving sustainable growth, margin expansion, and reliable long-term shareholder returns.

Catalysts

Provides defense, aerospace, and security solutions in the United States, the United Kingdom, the Middle East, Australia, Japan, Europe, and internationally.

• Intensifying public and political demands for defense budget reductions in Western countries may lead to a shrinking of BAE Systems' largest addressable markets, with future government spending at risk as social and fiscal priorities change, threatening long-term revenue stability despite today's strong backlog.
  
• Heightened ESG and sustainability requirements are likely to increase scrutiny from investors and financial institutions, which could restrict access to capital, elevate borrowing costs, and ultimately erode net margins as the company faces higher compliance and financing expenses.
  
• Accelerating protectionism and localization of defense procurement, particularly in the United States and Europe, may restrict BAE Systems' ability to win international contracts, directly limiting future top-line growth and undercutting its diversification strategy.
  
• The company's heavy reliance on a handful of massive multi-decade government contracts and programs increases concentration risk, making future earnings and cash flow highly vulnerable to potential delays, cancellations, or unfavorable renegotiations, especially in an environment of increasing geopolitical uncertainty.
  
• Rising R&D and adaptation costs to keep up with fast-changing technological requirements, combined with a risk of underinvestment in emerging areas like cyber defense and autonomy, threaten to compress margins and allow competitors to erode market share, with future revenue growth at risk as the industry pivots rapidly.

BAE Systems Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more pessimistic perspective on BAE Systems compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts.
• The bearish analysts are assuming BAE Systems's revenue will grow by 9.6% annually over the next 3 years.
• The bearish analysts assume that profit margins will shrink from 7.2% today to 7.1% in 3 years time.
• The bearish analysts expect earnings to reach £2.5 billion (and earnings per share of £0.86) by about August 2028, up from £2.0 billion today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 20.9x on those 2028 earnings, down from 26.6x today. This future PE is lower than the current PE for the GB Aerospace & Defense industry at 25.0x.
• Analysts expect the number of shares outstanding to decline by 0.56% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.16%, as per the Simply Wall St company report.

BAE Systems Future Earnings Per Share Growth

Risks

• Heightened global defense spending and escalating geopolitical tensions across NATO, Asia-Pacific, and the Middle East are driving multi-year increases in national military budgets, which underpins BAE Systems' robust £75 billion order backlog and provides exceptional revenue visibility and growth opportunities over an extended period.
  
• Strategic expansion into next-generation technologies-such as autonomous drones, advanced munitions, electronic warfare, and space systems-positions BAE Systems to capture emerging demand, with segments like FalconWorks and missile/missile defense solutions showing faster-than-portfolio growth, supporting both top-line momentum and long-term competitive relevance.
  
• A significant ramp-up in self-funded R&D, targeted acquisitions in high-growth areas, and increased capital expenditure in production and digitalization are improving innovation capacity while supporting structural net margin expansion, demonstrated by record double-digit EBIT growth and continued margin improvement across major divisions.
  
• Diversification of revenue streams through geographic expansion-especially in Australia, the U.S., Europe, Saudi Arabia, and Japan-reduces reliance on any single market and ensures resilience against local budgetary pressures, while major multi-decade programs (e.g., AUKUS submarines, Typhoon, FCAS/Tempest) lock in predictable revenues and earnings stability.
  
• Robust balance sheet management, investment in operational efficiency (automation, robotics), and a disciplined approach to capital allocation (dividends, buybacks, and value-accretive M&A) further reinforce BAE Systems' capacity to generate strong free cash flow, sustain earnings growth, and enhance returns to shareholders over the long term.

Valuation

• The assumed bearish price target for BAE Systems is £14.3, which represents two standard deviations below the consensus price target of £20.75. This valuation is based on what can be assumed as the expectations of BAE Systems's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of £25.0, and the most bearish reporting a price target of just £13.0.
• In order for you to agree with the bearish analysts, you'd need to believe that by 2028, revenues will be £36.1 billion, earnings will come to £2.5 billion, and it would be trading on a PE ratio of 20.9x, assuming you use a discount rate of 8.2%.
• Given the current share price of £17.6, the bearish analyst price target of £14.3 is 23.1% lower. Despite analysts expecting the underlying buisness to improve, they seem to believe the market's expectations are too high.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.