Is BAE Systems The Ultimate Retirement Share?

Published in Investing on 12 July 2012

Will shares in BAE help you build a FTSE-beating retirement fund?

The last five years have been tough for those in retirement. Portfolio valuations have been hammered, annuity rates have plunged and uncertainty has ruled the roost. There's no sign of things improving any time soon, either, as the eurozone and the UK economy look set to muddle through at best for some years to come.

A great way of protecting yourself from the downturn, however, is by building your retirement fund with shares of large, well-run companies that should grow their earnings steadily over the coming decades. Over time, such investments ought to result in rising dividends and inflation-beating capital growth, especially if you keep the shares within a tax-efficient ISA or SIPP.

It's no coincidence that the world's most successful investor, Warren Buffett, prefers such companies, and recently invested in a large FTSE 100 (UKX) company that fits the bill perfectly (you can find full details in this free report).

In this series, I'm tracking down the UK large caps that have the potential to beat the FTSE over the long term and support a lower-risk income-generating retirement fund. Today, I'm going to take a look at BAE Systems (LSE: BA), the UK's largest defence company.

Indecent exposure 

BAE's share price has been in the doldrums for the last few years but the company has remained profitable and pays handsome dividends to its shareholders. Most of BAE's sales come from the UK and USA, while India, Australia and Saudi Arabia are also important markets. Unfortunately, BAE's focus on the US and UK has meant that it has been exposed to recent defence spending cuts and the company's revenue fell by around 15% last year, although profits held firm and things are expected to pick up this year.

Sadly, BAE has not managed to outperform the FTSE 100 over the last 10 years, as these figures show:

Total Return (TR)20072008200920102011Trailing 10 yr avg.
BAE Systems TR19.8%-21.6%-0.6%-3.6%-8.2%2.9%
FTSE 100 TR7.4%-28.3%27.3%12.6%-2.2%5.9%

(If you are building up a retirement portfolio, total return is a useful metric for measuring the performance of your stock, as it captures the effects of share price changes and reinvested dividends. These two ingredients combined are what make it possible for equity portfolios to regularly outperform cash and bonds over the long term.)

These figures suggest that BAE felt the full impact of the recession later than the majority of other FTSE 100 companies, but that it is recovering more slowly, too. This makes sense when you consider that most of its income comes from large, public sector contracts, which are agreed well in advance of delivery. Cuts to future contracts take a few years to filter through to BAE's accounts, as can be seen from its below-par performance over the last two years.

What's the score?

To help me pinpoint suitable investments, I like to score companies on key financial metrics that highlight the characteristics I look for in a retirement share. Let's see how BAE shapes up:

ItemValue
Year founded1977*
Market cap£9.8bn
Net debt£1.4bn

5 year average financials

Operating margin9.5%
Interest cover8.5x
EPS growth31%
Dividend growth10.9%
Dividend cover2.61x
Dividend yield4.56%

*BAE Systems was formed as British Aerospace through the merger of four existing aviation companies.

Here's how I've scored BAE on each of these criteria:

CriteriaCommentScore
LongevityBAE's corporate history only stretches back to 1977, but its component parts are much older and its future as an independent British company seems fairly certain.4/5
Performance vs. FTSEIt's lagged the FTSE in recent years but has remained profitable. As long as this continues, the share price will eventually catch up -- and the current 6% dividend yield is ample compensation in the mean time.3/5
Financial strengthBAE's debt levels rose five-fold last year, thanks in part to a £500m share buyback. Despite this, net gearing is only 25% and interest cover is generous. BAE also has £2bn in cash.4/5
EPS growthEPS growth has been volatile over the last five years, but the trend is upwards.3/5
Dividend growthBAE has increased its dividend every year since 1999 -- a total increase of 135%. At the same time, dividend cover has remained strong.5/5

Total: 19/25

Dividend excellence has helped BAE Systems to a score of 19/25, a very respectable score that suggests that BAE could be a strong candidate for a retirement fund portfolio. Indeed, it's a share I hold myself.

If you are interested in finding more high-yielding shares, I would strongly suggest you take a look at some of Neil Woodford's choices. Neil is one of the UK's most successful fund managers and specialises in identifying companies with strong income potential. You can find out about eight of Neil's biggest holdings in this free Fool report, "8 Shares Held By Britain's Super Investor", which I strongly recommend, as many of Neil's picks are excellent retirement shares.

Warren Buffett buys British! The legendary investor has recently topped up on his favourite UK blue chip. Discover what he bought -- and the price he paid -- within our latest free report!

Further investment opportunities:

> Roland owns shares in BAE Systems.

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Comments

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countalucard 12 Jul 2012 , 12:10pm

I dipped my toe in the water with bae systems recently.
Currently i am waiting for blood on the streets before investing in diagio,reckitt b ,unilever,glaxco etc,etc.
Any other Fools waiting patiently too??

sopavest 12 Jul 2012 , 12:24pm

@countalucard

Me too -- I'm particularly keen on adding a miner (http://www.fool.co.uk/news/investing/2012/06/14/why-im-ready-to-buy-a-miner.aspx), but think they might get cheaper yet.

Like you, I'm also keen on Diageo and SABMiller, but I'm not sure they are actually going to get cheaper anytime soon. Although it'd be nice...

Cheers,

Roland (article author)

ukvalueinvestor 12 Jul 2012 , 12:31pm

countalucard, I'm not a massive fan of 'waiting' for things to get cheaper. That's effectively market timing and unfortunately the market will do whatever it wants, rather than what anybody else wants it to do.

A better approach may be to just work out what the most attractive opportunity is today and go with that.

There's always a high quality company selling at a discount somewhere.

John

Excel35 12 Jul 2012 , 12:37pm

Why does virtually every fool article have to mention Warren Buffet and the free related report, you have an ad with Warrens pic on every page for the article, isnt this enough.

Is ruining every article really worth while?

Oh and then the article finished of with the Neil Woodford report,,,, oh and then another Mention of the Warren Buffet free report.

IMO Cut the crappy free report ads from the article contents and put ads in the right hand menu of the page, you have plenty of space and your not ruining the content of your articles.

Or advertise on the site menus, directly whatever it is your then going to try and sell from the email addresses you get for the free reports.

As regards BAE Systems, it looks interesting, but I worry about companies that depend on contracts and government spending especially when money is very tight. Therefore growth is no assured and revenues and profits are bumpy, as might the dividend be in future.

Also has a large penison defiecit doesn't it?

Cisk999 12 Jul 2012 , 12:42pm

@countalucard

I hold some of the shares you mentioned but I buy them monthly. That way I'm not really concerned with the timing of a lump sum investment. Indeed I would rather the price go down so I can buy more each month. Buffett's words about stocks being the only prices people want to see going up echo in my ears.

I'm focusing on a rising dividend and gradual share price appreciation.

TD and Selftrade let you do this for up to 10 stocks (limited to funds and 350 stocks). iii I think let you do 20 stocks and they can be small caps too. They tend to charge £1.50 commission per trade.

Personally I don't hold BAE - mainly due to concern over their large pension deficit. I am keen on aerospace though and hold Senior, GKN, Rolls Royce and a couple of smaller players (well - tiny ones with a £15mkt cap).

I'm aiming to build the 'bedrock' of my portfolio this way - and really take a 5-10 year view. I then buy small and mid-caps (but lump sums) for a slightly riskier profile ;-)

Excel35 12 Jul 2012 , 12:46pm

@countalucard

I like the stocks you mention, but they are all having a very good run at present, as are many similar solid high dividend paying stocks.

MRW look like the opportunity of the moment.





4spiel 12 Jul 2012 , 12:46pm

I don't think anyone will lose their shirt on BAE but with tight Government spending I think dividend growth will be a problem. GSK Is worth the money but Unilever is overpriced and look to buy in rangev17-1750.-it was there not so long ago until it was ramped up ! Buy BAE when it gets back to 250p

ProfessorMarcus 12 Jul 2012 , 1:01pm

Hello countalucard.

I was waiting for shares like ULVR, RB., GSK etc. to dip in August 2011 but ULVR increased in price IIRC.

I eventually bought SSE as it fell to about 1200 but I'm still waiting to buy the others!

goodlifer 12 Jul 2012 , 1:37pm

countalucard
"Currently i am waiting for blood on the streets before investing in diagio,reckitt b ,unilever,glaxco etc,etc."

What makes you think the prices of the shares you mention are likely to go seriously down?

jongleur100 12 Jul 2012 , 2:01pm

Yes, I'm also waiting for RR, DGE and ULVR to weaken to a decent buy.
GSK however is currently looking like a good buy at 1443, though it might get back to below 1300.
SSE below 1300 would be nice.
I'm sceptical about BAE. How on earth is it going to solve its massive pension deficit problem? The scheme can be closed, but the liabilities will grow exponentially with QE and the gilt bubble. (There was a TMF article on that problem recently, but I can't seem to find it.)

Miners I'm a little wary of buying right now - China slowdown is more critical than eurozone worries for the global macro, imo.

kcod 12 Jul 2012 , 2:14pm

Query the figures in the first Table - they don't seem to stack up with the interpretation is the text. Also the company name seems to be "TBC".

Also, the 2nd Table states that the Div Yield is different to the Div Yield in the 3rd Table.

Makes one suspect all these figures - hopefully it's only the figures that are wrong and not the text.

sopavest 12 Jul 2012 , 2:54pm

Hi kcod,

The difference between the dividend yields is because the figure in the first table is a five-year average, whereas the yield I mentioned in the third table is the current yield, which is higher.

As regards the first table, I have to hold my hands up and admit that I entered the numbers the wrong way round -- the numbers themselves are correct. These have now been corrected by Fool HQ, so thanks for pointing this out -- and apologies for the confusion.

Regards,

Roland (article author)

BarneyCowshed 12 Jul 2012 , 4:35pm

When is this website going to stop wittering on about 'Legendary investor Warren Buffet's recent purchase of of a his favourite U.K Bluechip.

It's not that recent, I expect he's moved on. Time the Fool did the same

zubaduck 12 Jul 2012 , 6:48pm

senior has plummeted 12% since going on my watch list a few months back so I am not sure that it has done anywhere near as well as I had anticipated it would. Having said that though I think it may form into a decent buy in the not too distant future

as far as BAE is concerned, one unfortunate positive factor to the company's future is the global appetite for war which seems insatiable and regretfully may escalate. Governments always use an existing war as an excuse to push through highly costly new military orders and no opposition party ever dares to question the spending whilst soldiers are dying. I tend to think that Gov sets aside some it's most controversial and expensive military orders specifically for release during times of conflict. therefore BAE is, IMO (DYOR), a good candidate for the watchlist.

Xrat 12 Jul 2012 , 7:25pm

BAE is the only really big military player the UK has, and a lot of associated companies depend on it. I've held it for a few years and have been disappointed. That said there has been a lot of diversification, a lot of the company is now in computer security.

In it's favour..., 'Too big to fail,' springs to mind.

mrburns2050 13 Jul 2012 , 12:00am

i hold BAE bought a few months ago so am currently down a bit (5%) but its creeping back up. Am happy with the forecast yield. i buy long term and hold.

I to am sick of the warren buffet and Neil Woodford's links now see them coming and skip over the following 3 lines of writing.

Own DGE, ULVR and GSK bought when the going were good a year ago. More luck than judgement as i were new to investing and wanted a drugs, drink and products company. Missed out on SAB and BAT wish i had more money lol

Investing in MRW tomorrow through a share builder monthly plan. Seem cheap to me p/e 10 and 4% yield. Supermarkets seems to be taking a kicking at the min!!! why? (FOOL has not covered why.) rising profits (that i only see increasing) and a decent moat (cost to compete with the big 4) any one agree?

Also why do people believe RB is so stagnant? i see a strong company, strong product line and exposure to emerging markets all wins in my eyes. yet the proce has barley mover in a year.

cheers

Dan

jackdaww 13 Jul 2012 , 12:27pm

mrburns2050

agree on morrisons which i hold as well as tesco.

it ticks all my boxes in a business that has a long term future.

tesco stores i find dismal with customer averse staff.

morrisons have cheerful stores and customer facing staff.

no frozen fish and fresh veg and good cafeterias make it a no brainer for me.

all the supermarkets seem cheap.

bae may have issues with pensions , accounting and balance sheet - not for me.

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