Positive Medium-Term Outlook for BAE Systems Backed by Growing Defense Spending

Wide-moat BAE Systems increased order intake by 2.5% in 2021, exceeding expectations and bringing the total backlog to GBP 44 billion. Orders were evenly spread across domains and geographies. Sales and EBIT increased 2% and 8%, respectively, while margins slightly expanded to 10.3%. All divisions except air reported EBIT growth during the year. The group generated GBP 1.9 billion of free cash flow, up from GBP 1.4 billion in 2020. Management is guiding for 2022 midpoint revenue and EBIT growth of 3% and 5%, respectively, while cash flows should be greater than GBP 1 billion next year and exceed GBP 4 billion over the next three years. We are positive on BAE's growth prospects over the medium term, with margins and cash conversion set to improve on the back of improving business mix and efficiency gains. The group’s broad exposure to platforms and geographies allows for stable and predictable cash flows, underpinned by resilient defense demand and multidecade contracts. We don’t expect to make any major changes to our GBX 595/$32.50 fair value estimate; the shares appear slightly overvalued.