Shares in BAE jumped 150p at the sound of gunfire in Ukraine in February, and have been solid performers since then as first Boris Johnson and now Liz Truss have confirmed Britain’s support for President Zelensky.
Tipped here on March 2 at 710p, the shares reached 838p in July and are in demand at 805p as it becomes clear that western defence spending is set to climb for several years.
As well as operating in more than 40 countries, the group’s annual exports from the UK exceed £4 billion, a figure that will benefit from the weaker pound — every 5 cent drop in the dollar rate adds 1p to BAE’s earnings per share (EPS). It makes wide ranges of combat jets, tanks, armoured vehicles, ships and submarines and the drones, bullets, shells and missiles accompanying them. A report by Allied Market Research suggests that demand for small drones will more than triple to $24 billion a year by 2030.
Thanks to US government procurement policies, Europe is the company’s main, although not exclusive, focus. Chloe Lemarie at the investment bank Jefferies said: “The move to 2 per cent of GDP spent on defence could trigger a 25 per cent growth in non-US Nato members’ budgets, which may translate into as much as a 40 - 50 per cent growth in procurement spend over the next five years.”
BAE has been helping to modernise US Air Force F-15 jets as well as delivering combat vehicles to the US Army and Marine Corps.
The latest half-year sales and profits were only fractionally ahead at £10.5 billion and £1.1 billion respectively, but the key line in the interim bulletin was the order intake. At nearly £18 billion in the first six months, it was £7.4 billion up on 12 months earlier and only £3.4 billion below the figure for the whole of 2021. The backlog is £53 billion, more than twice annual sales, and a higher proportion of repeat orders will help keep costs down and margins up.
Charles Woodburn, BAE’s chief executive, said: “Our diverse portfolio, together with our focus on programme execution, cash generation and efficiencies, are helping us navigate the current macroeconomic challenges and position us well for sustained top-line and margin growth in the coming years.”
Inflation is a concern, for raw materials, energy and wages as the big manufacturers compete for a pool of experienced labour that is fairly fixed in the short term. But demand is such that much of this can be passed on. An advantage of the more urgent defence climate is that the company has been able to re-negotiate fixed-price contracts, although many were on a cost-plus basis. Armaments are now truly a sellers’ market.
A long-term shackle on the shares has been their understandable exclusion from ESG (environmental, social and governance) and other ethical funds, but that is having to be re-thought. The ethical lines are becoming blurred when arms are used to fight a foe like Russia.
Some funds, such as the ethical bank, Triodos, refuse to budge. A Triodos spokeswoman said: “It is misplaced to believe that investing in arms can ever be sustainable. This kind of investment also diverts funding away from conflict prevention.” Others are quietly beginning to reclassify it as no more than a grey area, which can only help BAE shares.
Jefferies has upgraded its forecasts, predicting that EPS will grow from 47.43p to 57.61p this calendar year, and 62.33p in 2023. While that is above the consensus of analysts, it would take the price-earning ratio below 13, a very modest rating in the circumstances.
ADVICE Buy
WHY Surging demand is supporting an already strong investment case for modestly rated shares
AG Barr
Strawberry Woo Woo and rhubarb syrup may not be everyone’s idea of tempting drinks, but mixed with gin and vodka they sell well in cocktail bars, adding to AG Barr’s collection of niche thirst-quenchers. Investors south of Hadrian’s Wall often struggle to appreciate how much the company’s fizzy soft drink Irn-Bru is a staple of Scottish life, on its own or accompanying alcohol of all types. Barr also makes Tizer.
These concoctions carry gross profit margins averaging a handsome 44 per cent. The latest addition to the stable, a 62 per cent stake in Moma oat milk, currently has a profit margin of only 33 per cent, but that will grow as introductory marketing and distribution costs fade. The astonishing one third of the UK population shunning cows’ milk for plant-based alternatives gave a platform for 16 per cent growth in the half-year to July 31. If all goes well, the Moma minority should be bought out before long.
Barr shares, recommended here in February at 498p, reached 575p in May then slipped to 454p because of concerns over rising inflation during the traditionally weaker second half.
Roger White, the chief executive, said last week: “We anticipate that the current economic environment will impact consumer purchasing behaviour.” Another drag is the Scottish government’s planned deposit return system, charging 20p a bottle refundable on return, which could cost Barr £3 million a year from next August.
The share price has recovered a little on further consideration of the broader picture. Barr’s brands are all solid performers with excellent long-term prospects and, as Moma shows, the management is open to adding to the portfolio.
White said: “We remain confident that our strategy and actions will allow us to deliver a full-year profit performance ahead of the prior year.”
Investec’s analysts see pre-tax profits edging ahead from £41.5 million to £42 million this year, but then advancing to £44.2 million and £46 million. That should take the price-earnings ratio down to an undemanding 15, while the dividend yield is expected to grow to 3 per cent in that time.
ADVICE Hold
WHY Brands strong enough to withstand current headwinds
