Like many others, the BAE Systems’ (LSE: BA) share price has dropped lately. In fact, it’s down 8% from 3 June when it was at a 12-month high of £13.99.
That said, it is still up 35% from its 17 August 12-month traded low of £9.55. And since 24 February 2022 when Russia invaded Ukraine, it has jumped 113%.
The key question to me at this point is whether there is significant value left in the shares after such a rise. If so, it might well be worth my while using the current price dip to buy more.
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How does the share valuation look now?
BAE Systems is currently trading at the second lowest price-to-earnings ratio (P/E) among its peer group, which averages 42.2.
It is at 20.9, while Rolls-Royce is at 16.8, L3Harris Technologies is at 36.7, TransDigm is at 46.8, and RTX is at 68.4.
It looks equally cheap on its price-to-book (P/B) ratio of just 1.6 against its competitors’ average of 3.9.
So, how much of a bargain is it in monetary terms? To ascertain this, I used a discounted cash flow analysis, taking several other analysts’ figures and my own.
This shows BAE Systems’ shares to be 24% undervalued at their present price of £12.90. So a fair value for them would be £16.97, although they may go lower or higher than that.
Is the business outlook strong?
Ultimately, a firm’s share price is driven by earnings, and BAE Systems looks good to me from this perspective.
A key risk in the stock is if the world suddenly becomes a more peaceful place, much as we want that. Another risk would be a failure in any of its major products, as these could prove very costly to remedy.
That said, analysts estimate that its earnings and revenue will, respectively, grow by 7.7% and 8.6% a year to end-2026. Earnings per share are expected to increase by 9% a year to that point. And return on equity is forecast to be 17.9% by then.
Its H1 2024 results look supportive of this good growth outlook, in my view. Sales jumped 13% to £13.399bn from H1 2023, while operating profit rose 5% over the period, to £1.296bn.
These gains were powered by a £1.6bn increase in its order book over the six months, to £59.6bn. Its order backlog jumped £4.3bn over the period to £74.1bn.
So will I buy more?
There is an old military saying that runs, ‘If you want peace, prepare for war’. Given the heightened tensions in Europe, Asia, and the Middle East, this is likely to be a key driver for defence spending in the coming years.
Earlier this year, European NATO members announced their intention to increase theirs to 2%+ of gross domestic product (GDP) annually.
It has been estimated that they must spend €1.8trn to compensate for 30 years of underinvestment. As the largest defence contractor in Europe, BAE Systems is in a prime position to benefit from this.
Consequently, I will be adding to my holding in the company very soon.
