February 21, 2013 3:24 pm

BAE Systems: on the defensive

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Europe’s biggest defence contractor is in search of post-merger failure strategy

Is that it, then? One minute planning the merger to end all mergers, the next throwing money at shareholders for want of better ideas? It is easy to be cynical about the £1bn share repurchase plan announced by BAE Systems on Thursday. Reduced horizons after the failed EADS merger! Nothing better to do with the cash! But seriously, what else is Europe’s biggest defence contractor by sales going to do with its money? Big-ticket M&A is off the agenda; the pension deficit is being nursed along; organic growth is what it is; and the dividend has been lifted 4 per cent. What is wrong with a little support for the share price?

Since the collapse of the merger plan in October, BAE’s shares have risen 16 per cent (including yesterday’s 4 per cent pop after the 2012 results). That is respectable for a company in search of a grand strategy. But its shares still trade on a forward earnings multiple of just 8.5 times versus the industry average of a bit over 11 times. EADS trades on 14 times; Safran, the French aerospace group that also reported on Thursday, is on 12.5 times. So BAE’s shares are about the cheapest thing that BAE could buy right now – arguably cheaper than another bolt-on acquisition or two. And it has net cash of £400m after generating £2.7bn of operating cash flow in 2012, more than four times the 2011 level.

There are a lot of clouds over defence spending. One is the threat from sequestration, the measure to reduce the US deficit by $1.2tn via automatic spending cuts, which BAE estimates could knock 6 per cent off group revenue and earnings if it occurs indiscriminately. Then there is Europe’s crisis. Hunkering down is one way of facing them; that is what BAE is doing. If the sector’s clouds lift, its shares will look bright. In the meantime, BAE is in search of a strategy that is at least as convincing as the EADS merger. Until it comes up with one, boosting shareholder returns through buybacks is as good as it gets.

Email the Lex team in confidence at lex@ft.com

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