STOCK TO WATCH: BAE SYSTEMS

There is no doubting the fact that the Ukraine war has been good for business for BAE systems. Insofar that there was an initial stock surge when the war started the fact the PE ratio is currently 13 suggests it could be under-valued still. While the PE ratio alone is insufficient to determine if this is a good buy, there are other factors which are worth considering.

Point 1.

Sunak’s rhetoric regarding supporting Ukraine and budgetary commitments to Defense at the moment are not aligned. BAE Systems are the leading munitions provider to the British Government, where at this point, the UK has donated nearly all its spare stock and has yet to place orders to replace it.

For the UK to just continue to support Ukraine in the way it has been, Defense spending will need to increase and munitions (and with that orders to BAE systems) will need to increase also. The war between Ukraine and Russia will not end any time soon either. What that means is that at some point, the British Government will be forced to increase spending as a function of GDP.

As a historical note, during the cold war, up to 8% of GDP was spent on defense, now this has fallen to 2%. At the same time, the Ukraine war is showing that there is a real need for the UK to scale up its armed forces to ensure it can deliver on its commitments in light of this new state of affairs.

Point 2.

Geopolitically as well we are entering an era of instability and uncertainty. Ukraine is at war today. Equally all around the world we are seeing flashpoints emerge for Taiwan to Iran. The move to by NATO to work closer with Asian Partners such as Japan, South Korea and Australia means it is increasingly likely we will see greater militarization across the Pacific.

If the best Defense is a strong offensive capability, then BAE Systems are likely to be at the forefront of investment into next generation weaponry to enable NATO nations to stay ahead.

Point 3.

Finally, we are about to enter a new frontier, the space era. At the moment space has yet to be militarized, equally that is unlikely to be the case for long. Up to now militarization has been a moot point as there has been little value in doing so, but Space X has changed that. Suddenly the Russians are talking very seriously about shooting down Space X satellites as they are giving Ukraine a clear competitive advantage. Imagine there is a conflict in Taiwan where the Chinese are similarly compromised. If the US and its partners don’t start militarizing space to secure key assets, it is logical they will become at risk.

While it is hard to say when exactly this will happen, if we assume logically there will be another burst in spending to secure in orbit assets, one can assume BAE systems will be front of the line and will secure as a result a significant new revenue stream.

Given the above, it is my belief that the long-term fundamentals make this company worth considering as a long-term hold, especially as the dividend at 3% is generous, meaning there should be some good returns as well in the meantime.