Rising Global Defense Spending Will Unlock Secular Opportunities

Key Takeaways

• Multi-decade, government-backed order book and digital transformation provide reliable, scalable revenue streams, supporting sustained margin and dividend growth above expectations.
  
• Leadership in advanced technologies and disciplined expansion position BAE to capture transformational upside from global defense rearmament and secular security shifts.
  
• Heightened regulatory and ethical pressures, customer concentration risks, and slow adaptation to new defense technologies threaten BAE Systems' growth, margins, and future competitiveness.

Catalysts

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

• Analysts broadly agree that BAE's record order backlog of 78 billion pounds signals strong future revenue growth, but this view significantly understates the durability and earnings reliability of BAE's order book, which is tied to multi-decade, government-backed programs and provides unprecedented medium
• and long-term revenue and cash flow visibility, supporting sustained margin and dividend expansion.
  
• Analyst consensus sees global defense spending increases as a key catalyst, yet recent paradigm shifts in European security and rising threats in Asia-Pacific signal a step-change, not just a cycle, in defense outlays; as Europe's largest defense prime, BAE is uniquely positioned to capture transformational upside from rearmament and modernization waves that could accelerate sales and compound net margin expansion for a decade or more.
  
• Unlike peers, BAE has built a leadership position in space, advanced electronic warfare, and counter-drone solutions through aggressive self-funded R&D and strategic M&A, enabling it to outpace industry growth and shift its business mix toward higher-margin, next-generation technology contracts, leading to top-line and margin growth well ahead of consensus expectations.
  
• BAE's advanced manufacturing investments and digital transformation are driving rapid operational scaling and resilience, positioning the company to respond to demand surges and adapt supply chains faster than competitors, which will allow BAE to seize market share, unlock cost efficiencies, and deliver above-trend EBIT growth if geopolitical tensions escalate further.
  
• The company's capital allocation discipline and robust balance sheet position it to accelerate further inorganic growth, especially in underpenetrated continental European and Indo-Pacific markets, tapping into secular growth engines and broadening the global addressable market, supporting a compounding acceleration in earnings and free cash flow far above what is currently priced in.

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 12.8% annually over the next 3 years.
• The bullish analysts assume that profit margins will increase from 7.4% today to 7.8% in 3 years time.
• The bullish analysts expect earnings to reach £2.9 billion (and earnings per share of £1.0) by about July 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 30.4x on those 2028 earnings, up from 28.4x today. This future PE is greater than the current PE for the GB Aerospace & Defense industry at 29.0x.
• Analysts expect the number of shares outstanding to decline by 0.42% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.91%, as per the Simply Wall St company report.

BAE Systems Future Earnings Per Share Growth

Risks

• Increasing emphasis on global emissions reduction, along with heightened environmental regulations, could result in higher compliance costs and diminished competitiveness for BAE Systems' traditional defense platforms that rely on fossil fuels, exerting downward pressure on future contract wins and revenue growth.
  
• Intensifying anti-defense sentiment in Western countries-and the potential for peace-driven budget constraints-could lead to stagnation or even reductions in core defense budgets, risking a plateau in key market orders and limiting the company's future top-line revenue expansion.
  
• The company's persistent reliance on large government contracts with a few major customers, specifically the UK, US, and Saudi Arabia, exposes BAE Systems to outsized customer concentration risk; any loss, delay, or renegotiation of these long-cycle contracts could create significant volatility in annual earnings and sales.
  
• As defense procurement increasingly favors commercial technologies like software, COTS hardware, and AI, BAE Systems' continued focus and investment in legacy platforms and slower adaptation to new defense tech trends may result in declining market share and below-peer growth, ultimately constraining long-term revenues.
  
• Governments and institutional investors are applying greater scrutiny to ethical supply chains, human rights, and ESG-related practices; this could expose BAE Systems to reputational risks, exclusion from ESG-linked funds, and potentially higher costs of capital, negatively impacting net margins and financial flexibility over time.

Valuation

• The assumed bullish price target for BAE Systems is £24.0, 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 £24.0, 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 £37.8 billion, earnings will come to £2.9 billion, and it would be trading on a PE ratio of 30.4x, assuming you use a discount rate of 7.9%.
• Given the current share price of £18.59, the bullish analyst price target of £24.0 is 22.5% 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.