Investments In Space, AI, And Drones Will Secure Future Leadership In Defense Technologies

Key Takeaways

• Record order backlog and alignment with global defense spending will drive revenue growth and margin expansion through strategic national defense alignments.
  
• Investments in R&D and strategic acquisitions will enhance revenue and earnings, supporting leadership in defense technologies and operational efficiency initiatives.
  
• Regulatory pressures and scaling challenges, combined with evolving defense needs and rising competition, could impact BAE Systems' revenue, market share, and margins.

Catalysts

Provides defense, aerospace, and security solutions worldwide.

• BAE Systems has a record order backlog of £78 billion, suggesting strong future revenue growth as this backlog is converted into sales.
  
• The anticipated increase in global defense spending, particularly in Europe, Asia-Pacific, and the Middle East, is likely to drive revenue growth and margin expansion as BAE aligns with national defense strategies.
  
• Investments in self-funded R&D, especially in space, electronic warfare, AI, and drones, are expected to lead to margin expansion and top-line growth as these areas become increasingly critical.
  
• The company's strategic acquisitions, such as Ball Aerospace and capabilities in space and counter-drone technologies, are expected to enhance revenue and earnings, positioning BAE as a leader in defense technology markets.
  
• BAE's operational efficiency improvements and digital transformation initiatives are expected to sustain margins and boost cash flow, supporting continued dividend payments and possible share buybacks.

BAE Systems Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming BAE Systems's revenue will grow by 9.5% annually over the next 3 years.
• Analysts are assuming BAE Systems's profit margins will remain the same at 7.4% over the next 3 years.
• Analysts expect earnings to reach £2.6 billion (and earnings per share of £0.86) by about February 2028, up from £2.0 billion today. However, there is some disagreement amongst the analysts with the more bearish ones expecting earnings as low as £2.2 billion.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 21.3x on those 2028 earnings, up from 19.1x today. This future PE is lower than the current PE for the GB Aerospace & Defense industry at 21.6x.
• Analysts expect the number of shares outstanding to decline by 0.2% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.37%, as per the Simply Wall St company report.

BAE Systems Future Earnings Per Share Growth

Risks

• Potential risks from the regulatory environment, particularly in the U.S. where there may be pressure from the Department of Defense Efficiency (DOGE) initiatives to reduce budgets or transition force structures, which could impact BAE Systems' revenue from U.S. government contracts.
  
• Execution challenges related to rapid scaling of production to meet increased demand, particularly in areas with complex supply chains like MBDA's missile systems, could hinder sales growth and supply chain costs, affecting revenue and margins.
  
• The evolving defense needs in space, drones, and counter-drone could necessitate significant R&D investment, which while beneficial long-term, may pressure short-term earnings and margins if new technologies don't perform as expected or market demand shifts.
  
• Rising competition in the defense market, particularly around drones, counter-drones, and other emerging technologies, could challenge BAE's market share and pricing power, impacting revenue growth and margins.
  
• Economic or political instability, particularly in regions like Europe or Asia-Pacific where BAE is expanding or looking to grow, could negatively impact government defense budgets and delay expected contract awards or renewals, thus affecting future revenue streams.

Valuation

• The analysts have a consensus price target of £14.805 for BAE Systems based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of £16.85, and the most bearish reporting a price target of just £12.25.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be £34.6 billion, earnings will come to £2.6 billion, and it would be trading on a PE ratio of 21.3x, assuming you use a discount rate of 7.4%.
  
• Given the current share price of £12.56, the analyst price target of £14.81 is 15.2% higher.
  
• 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.