BAE Systems’ (LSE: BA) share price showed little reaction to the 19 February release of its full-year 2024 results. This might have appeared odd to the casual observer, given how good the numbers were.
In my view, it reflected two factors. The first was the 8% run-up in price in the two days before the results announcement. Overall, it’s gained 105% from 24 February 2022 when Russia invaded Ukraine.
In short, much of the passive price reaction to its results looked like simple profit-taking to me.
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The other part comes from a view in the markets that the world may become more peaceful, in my opinion. After all, negotiations are afoot to end the Russia/Ukraine war and there’s a truce in the Israel/Hamas conflict.
Are the bearish stock factors short term only?
I believe neither of these bearish share price factors will last much longer.
I think much of the expected profit-taking has washed through the share price in the past couple of months. And I believe any settlement to the Russia/Ukraine war reached without input from Ukraine and Europe won’t last. Even if it did, European NATO members are now on high alert for further Russian aggression on their borders.
This will result in much higher defence spending. NATO Secretary-General Mark Rutte now expects over 3% of member countries’ gross domestic product to be allocated to this. US President Donald Trump has called for the figure to be increased to 5%.
Even to reach the current 2% target, estimates are that €1.8trn (£1.5trn) must be spent to compensate for 30 years of underinvestment.
The current truce between Israel and Iran’s proxies, Hamas and Hezbollah, also looks highly fragile to me.
What does this mean for the stock?
As Europe’s largest defence contractor and the world’s seventh biggest, BAE Systems should benefit from increased spending.
A risk to the firm is any major fault in one of its key products. This could be costly to remedy and could damage its reputation long term.
However, consensus analysts’ forecasts are that its earnings will increase by 7.2% each year to the end of 2027. It’s this growth that ultimately drives a firm’s share price (and dividend) higher.
That said, these bullish forecasts look on the low side to me. In its 2024 results, BAE Systems said it expects its earnings to grow 8-10% in 2025. It also forecasts its sales to rise 7-9% over the period.
In 2024, its earnings jumped 14% year on year to £3.015bn, with sales increasing the same level to £28.335bn. Profit rose 4% to £2.685bn.
Will I buy the stock?
Given the operational backdrop and the earnings growth potential, BAE Systems’ share price is an irresistible buying opportunity for me and I will be adding to my existing holding very soon.
To establish a price target for me to buy, I ran a discounted cash flow analysis. Using other analysts’ figures and my own, this shows the shares are currently 51% undervalued at £12.61.
Therefore, their fair price is technically £25.73, although market vagaries could push them lower, or higher.
