Geopolitical Tensions And Cyber Advances Will Drive Defense Industry Strength

Key Takeaways

• Dominant positions in flagship defense programs, technological leadership, and broad geographic reach enable BAE to outperform peers and capture long-term above-expectation revenue and profit growth.
  
• Superior innovation, first-mover advantages, and scalability drive stronger margins, enhanced cash flow, and substantial returns to shareholders through dividends and buybacks.
  
• Shifting geopolitical dynamics, ESG scrutiny, technological disruption, government dependency, and legacy liabilities all challenge BAE's long-term revenue growth and financial agility.

Catalysts

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

• Analyst consensus sees the £78 billion order backlog as positive, but this narrative understates both the duration and growth of opportunities: BAE holds incumbent positions for multi-decade flagship programs (such as GCAP and SSN-AUKUS) and benefits from a new opportunity pipeline approaching £260 billion, which could support structurally higher long-term revenue and profit growth beyond current expectations.
  
• Analysts broadly agree that margin expansion will result from investments in advanced technologies and operational efficiency, but the rapid early success of FalconWorks and BAE's lead in European drone/counter-drone markets suggest the company could achieve accelerated margin growth as disruptive technologies capture a premium share of rising global defense budgets, leading to a step change in group-wide profitability.
  
• BAE's geographic and product diversification-including its dominant roles in the U.S., U.K., Australia, and the Middle East-positions it to win disproportionately from the simultaneous and sustained global ramp-up in defense spending, supporting stronger-than-expected revenue compounding and providing resilience to regional shocks.
  
• The convergence of technological innovation and escalating geopolitical tensions creates a flywheel for sustained contract wins and first-mover advantages in high-growth segments like military drones, hypersonic defense, space systems, and electronic warfare-allowing BAE to accumulate intellectual property and deepen customer lock-in, ultimately yielding superior pricing power and higher net margins over the long term.
  
• The company's ability to rapidly scale production in response to demand-as seen with Hägglunds, Bofors, MBDA, and Typhoon-combined with ongoing investments in automation and supply chain enhancements, suggests a structural step change in operating leverage; this will not only drive substantial free cash flow growth but also enable an above-peer pace of dividend growth and buybacks.

BAE Systems Future Earnings and Revenue Growth

Assumptions

• This narrative explores a more optimistic perspective on BAE Systems compared to the consensus, based on a Fair Value that aligns with the bullish cohort of analysts.
• The bullish analysts are assuming BAE Systems's revenue will grow by 11.5% annually over the next 3 years.
• The bullish analysts assume that profit margins will increase from 7.2% today to 8.1% in 3 years time.
• The bullish analysts expect earnings to reach £3.1 billion (and earnings per share of £1.04) 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 bullish analyst cohort, the company would need to trade at a PE ratio of 30.2x on those 2028 earnings, up from 26.8x today. This future PE is greater 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

• A long-term trend toward global de-escalation and diplomatic solutions could lead to a reduction in defense spending, shrinking BAE Systems' addressable market and constraining future revenue growth.
  
• Increasing societal and investor scrutiny around ESG factors may restrict institutional investment into defense companies like BAE, elevating their cost of capital and potentially weighing on the valuation and future earnings.
  
• Rapid evolution in technological domains such as cyber, AI, and space-based warfare risks rendering BAE's core strengths in traditional hardware less relevant, which could result in product obsolescence and lower long-term revenues and margins.
  
• Heavy reliance on large, multi-decade government contracts means BAE is exposed to political, regulatory, and budgetary changes; any shifts or delays in procurement cycles or export restrictions could reduce backlog conversion and revenue predictability.
  
• BAE's considerable pension and legacy benefit obligations could increase due to demographic shifts or asset underperformance, diverting cash flow, pressuring net income, and limiting financial flexibility to invest in future growth initiatives.

Valuation

• The assumed bullish price target for BAE Systems is £25.0, which is the highest price target estimate amongst analysts. 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 bullish 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 bullish analysts, you'd need to believe that by 2028, revenues will be £38.0 billion, earnings will come to £3.1 billion, and it would be trading on a PE ratio of 30.2x, assuming you use a discount rate of 8.2%.
• Given the current share price of £17.75, the bullish analyst price target of £25.0 is 29.0% 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.