BAE Systems (LSE: BA.) shares have slumped more than 10% in the last week, one of the FTSE 100‘s biggest fallers in that time. That may surprise investors given this is supposed to be one of the most solid blue-chip stocks of the lot, bolstered by a staggering £84bn order backlog. What’s going on?
It’s particularly odd when you consider that BAE makes weapons, and the war in Ukraine tragically is as brutal as it ever was, while the Iran war drags on and relations with China are hardly improving.
Why has this FTSE 100 stock fallen?
The dip makes more sense when you look at the stock’s valuation. BAE has been trading on a price-to-earnings ratio of 27x or 28x, well above the FTSE 100 average. Buyers may simply have decided it’s too expensive, while some existing investors have been banking profits.
There’s another factor. The US midterm election results could hit Donald Trump’s defence spending plans. That’s unsettling for BAE, which generates substantial business in America. Many are wondering whether the extraordinary growth expectations priced into the defence sector can be sustained.
Yet the company’s actual performance has been impressive. First-half results (30 July), showed sales rising 9% to £15.8bn, beating expectations, with every division delivering growth.
Underlying operating profit rose 11% to £1.7bn, while free cash flow swung from an outflow of £368m a year earlier to an inflow of £1.8bn. The board also reduced net debt by £600m to £3.2bn. It’s running share buybacks too.
Having upgraded full-year guidance and increased the interim dividend by 11%, you might have expected the shares to fly. Instead, they’ve fallen around 18% since those results and are back to where they were 12 months ago.
Can it recover from here?
So what do the experts think? The 18 analysts offering one-year share price forecasts produce a consensus target of 2,350p. If correct, that would give investors a capital gain of roughly 25% from today’s £18.81.
Of course, forecasts are educated guesses, not promises. Yet that target suggests analysts believe the recent sell-off may have created an opportunity.
Any dividend income comes on top. BAE currently yields around 1.93%, which isn’t spectacular, but shareholder payouts are growing nicely.
BAE has something many companies would envy: exceptional earnings visibility. Defence contracts often run for years, giving manufacturers a substantial pipeline of future business.
There are risks though. BAE could get its pricing wrong, supply chain bottlenecks could delay deliveries and government budget pressures might rein in defence spending. Despite the recent retreat, the shares aren’t exactly cheap.
It’s well worth considering
After such a spectacular run, BAE Systems was always going to have periods of profit-taking. But I don’t think its long-term growth story has suddenly disappeared.
I think the shares are worth considering today. Drip-feeding money in rather than investing everything at once may be the wiser approach. Just don’t assume the shares will definitely jump 25% over the next year, and look to the longer term.
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Harvey Jones owns shares in BAE Systems
This story originally appeared on Motley Fool
