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Up 46% in the past year, should I be looking at BAE’s share price?

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BAE Systems (LSE: BA.) shares have surged an incredible 46% over the past year as the defense contractor benefited from heightened geopolitical tensions and increased global military spending. But after such a strong run, should investors be taking a closer look at BAE’s share price?

A solid year

A quick look at BAE’s recent fundamentals helps explain the impressive share price performance. In its latest results, the company reported an 8.6% rise in revenue to £23.1bn and a 10.2% rise in underlying earnings per share (EPS). Order backlog grew to a record £69bn, providing incredibly strong multi-year visibility.

The company’s diverse business mix across defense domains such as air, naval, electronic systems, and intelligence services enabled it to leverage the growing budgets of key customers such as the UK, US, Saudi Arabia and others. The Ukraine conflict was a major trigger for NATO. Countries will increase defense spending after years of underinvestment. Recent tensions and conflicts in the Middle East have exacerbated this.

Basics

Looking at some key financial metrics, the business is currently valued at a price-to-earnings (P/E) ratio of around 16 times compared to its five-year average of 16.5. The dividend yield of 3.3% is also quite attractive, but slightly behind FTSE 100 The index averaged 3.5%.

While the valuation appears to be slightly inflated, my main concern is whether the growth outlook can continue to drive the share price higher. Analysts forecast the company’s revenue to grow at around 6.7% annually over the next few years. This is solid, but not spectacular, growth that may come at a price already given geopolitical risks are still high.

Much will depend on whether NATO countries maintain policies of increasing defense spending going forward while threats from Russia, China, Iran and others persist. Any shift back to the previous ‘peace dividend’ mentality of military budget cuts could quickly erode the positive outlook.

The company also faces some near-term cost pressures and supply chain challenges that could squeeze margins over the next year or two. I suspect high interest rates are another potential headline given the huge debt load of around £5.3bn.

Future

On the positive side, BAE has a strong pipeline of major, multi-year programs such as the UK’s Dreadnought nuclear submarine and Eurofighter Typhoon fighter jet. Its intelligence and cyber capabilities also position it well in areas such as AI, autonomous systems, and cyber security that are top priorities for the defense establishment.

So while BAE Systems’ share price has seen an impressive run of late, I’m not sure the upswing is over just yet. With strong order flow, reasonable valuations, and influence in areas of secular growth, there’s a lot to like here, even if the returns are higher elsewhere. I will add this to my watchlist pending further research.


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