BAE Systems finals

A global defence, aerospace and security company. BAE Systems delivers a range of products and services for air, land and naval forces, as well as advanced electronics, security, information technology solutions and support services.  I have a holding in my income portfolio (epic code: BA.)

BAE released their final results today. Sales were down 8.5% to £15.4bn, although 3.3% of this decline was due to currency translation.  Operating profit was up 61.3% to £1.3bn, principally due to a £717m reduction in impairment of intangible assets, where last year they took a charge relating to the US Intelligence & Security and Land & Armaments businesses, due to the expected decline in US DOD expenditure.

Results by segment were:
 

Click on table to enlarge

Reported EPS was 23.3p, up from 5.2p last year.  Normalised EPS was down 9.3% to 37.9p and was at the bottom end of their guidance of 37.8p to 39.9p and below my estimate of 38.7p (see here). 

In 2015, management expect the Group's underlying EPS to be marginally higher than in 2014.

A final dividend of 12.3p has been declared making 20.5p for the year, an increase of 2% and covered 1.14x by earnings.

Free cash flow showed an improvement on last year's outflow of -£368m, but was well down on earlier years at £354m.  The free cash flow was improved by the addition of £418m on the sale and lease back of properties in Saudi Arabia, so the resultant £772m was sufficient to cover the dividends paid of £642m, but debt was increased by £0.3bn to £1bn to pay for £282m of share buy-backs and £233m for acquisitions.

Gearing was increased from 20.8% last year to 56.2%, the result of the increased debt mentioned above and a £1.5bn reduction in equity, that included £2bn for the increased deficit of their defined benefit pension schemes.  Net debt is 0.6x EBITDA and operating cash flow is 65% of net debt, so reasonably comfortable, although it would be good to see dividends and buy-backs covered by FCF in the future, so that this position does not become strained.

Return on capital employed (ROCE) is exceptional at over 40% compared to a weighted average cost of capital of about 9%.  This high level of ROCE is achieved by low levels of working capital requirements, more than off-setting mediocre operating margins.  Their 3 year average FCF return on capital employed is good at 15%, but is bolstered by strong FCF three years ago, so that this metric will fall if 2015 does not see a return to a £1bn+ FCF.

In addition to the guidance for 2015 mentioned above, CEO King said "...Looking ahead, defence spending remains a high priority in a number of international markets. In the UK, we benefit from long-term contracts, notwithstanding continued pressure on public spending. We believe US budgets are now relatively stable, with some early indications of a modest improvement in 2016..."

So 2015 is going to show a marginal improvement on 2014 and 2016 may start to show a better picture, with modest improvement in US spend, higher spend in international markets and stability in the UK with a substantial order book.  Currently cash outlay on pension costs, that are above the normal service costs, have been around £390m pa which are manageable; based on the latest triennial valuation this looks to be set at about that level for the next 3 years.  In summary the dividend over the next 2-3 years looks safe and yields around 4% at the current price of 526p.