Should I Buy BAE Systems?

Published in Company Comment on 14 December 2012

Harvey Jones sizes up BAE Systems (LSE: BA.).

It's time to go shopping for shares again, but where to start? There are loads of great stocks to choose from, and I've got my wallet out. So here's the question I'm asking right now. Should I buy BAE Systems (LSE: BA) (NASDAQOTH: BAESY.US)?

Guns & ammo

BAE Systems is a FTSE 100 (UKX) stock with plenty of firepower. One of the world's biggest weapons and aviation groups, it sells fighter planes, missiles, warships and ammunition to almost 80 countries. Should love, peace and harmony break out on a global scale, BAE Systems would be the loser, but investors will rest easy on that score. This stock's real firepower comes in the shape of its yield, a gun-happy 5.5%. So should I buy it?

Shotgun wedding

It isn't all war-war at BAE Systems, there has been plenty of jaw-jaw lately -- in fact, rather too much of it, over the proposed merger with Franco-German owner of Airbus EADS. The £29 billion merger would have created the world's largest defence, security and aerospace group, a worthy rival to Boeing. It was widely thought to favour BAE Systems and, when it collapsed in October over political difficulties, BAE's share price tumbled while EADS's rose. Yet the deal would have upset BAE shareholders, because management had pledged to bring the two yields into line. Since BAE yields more than 5% and EADS less than 2%, investors could have lost heavily. The share dip (and buying opportunity) was brief, as BAE's share price has been going great guns since, rebounding to £3.39.

Gone East

I'm not a big fan of major mergers. There is just too much that can go wrong, so I'm glad this was shot down. The new entity would have struggled to generate cost savings under stiff resistance from trade unions here and overseas. I don't much like dividend cuts, either, especially since BAE Systems was pursuing a progressive dividend policy. BAE Systems has now won its first major contract since the failed merger, a £1.2 billion deal to build nuclear submarine HMS Audacious for the Royal Navy. With defence spending in the US and UK under pressure, BAE Systems needs to spread its wings. It is looking to boost sales in the Middle East, and is said to be closing in on a deal to sell 12 Typhoons to Oman. It is also renegotiating the contract for the sale of 72 Typhoons to Saudi Arabia, which should generate up to £600 million, some of which could find its way into the pockets of shareholders via a special dividend or share buyback.

Fire sale

This isn't a soaraway stock. Earnings per share are growing only modestly. Sales growth is slow. The US is looking to cut $600 billion from its defence budget over the next 10 years and BAE Systems faces a battle hard to maintain its strong position in the Middle East. But there are strong potential growth areas, notably in cyber security. And there's always the Saudis, who should keep spending as long as the oil price is high and the region insecure, which seems a safe double bet. There is also that 5.5% yield, covered 2.4 times. You can buy Britain's biggest manufacturer on a P/E ratio of 8.6 times earnings, which is also tempting. But with sales growth set to remain flat, don't expect fireworks.

Bullet proof

If you don't think BAE Systems is a bullet-proof investment right now, you might want to take aim at the one UK share that Warren Buffett loves. This special in-depth report is completely explains exactly why Warren Buffett bought this share. Better still, it is completely free and without any obligation. Availability is strictly limited, so if you want to know the name of this company, please download it now.

> Harvey doesn't own any shares mentioned in this article.

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