BAE Systems: Increasing Fair Value Estimate on Improved Defense Spending Outlook

We are maintaining our wide moat rating and raising our fair value estimate for BAE Systems BA. to GBX 1,170/$59 per share to reflect our outlook for higher defense spending over the medium term, programs moving toward full-rate production, and performance improvements.

All BAE segments should see growth, especially air and platforms and services. We project a 9% annual increase in adjusted EBIT from 2022 to 2027, aligning with the FactSet consensus and BAE’s midterm goals.

The air segment, led by the F-35 and Typhoon fighter jet programs, should grow 6.5% yearly over the next five years, with margin increases driven by the F-35 ramp-up.

We expect platform and services to exhibit one of the highest growth rates, driven by the Hägglunds combat vehicle segment. U.S.-based combat mission systems will also see growth driven by potentially 1,000 Vietnam-era vehicles that need to be replaced. We expect a 150-basis-point increase in the platform operating margin from 2022 to 2026, driven by multiple programs entering full-rate production in 2023.

A major contributor to our forecast EBIT growth is the acquisition of Ball’s aerospace business, expected to be completed in 2024. In our assessment, the strategic alignment of this acquisition is compelling and moat-accretive, as it will create a stickier offering through product integration, particularly in electronic warfare. The valuation appears fair, as we anticipate that return on invested capital will surpass weighted average cost of capital in the initial five years after the acquisition.