Defence giant BAE Systems (LSE: BA) (NASDAQOTH: BAESY.US) is a core element of many investors income portfolios including my own.
The firms share price performance has matched that of the FTSE 100 over the last five years, climbing by around 45%, but BAEs high yield has helped the defence giant beat the index, with BAE delivering an average total return (capital gains plus dividends) of 11.9% per year, compared to 11.1% for the FTSE 100.
However, BAEs dividend could be losing its shine: the firm is only expected to increase its payout by 1.4% this year, and by 2.4% next year.
Problems?
Lets start with the basics: how is BAE valued against its historic and forecast performance?
|
P/E ratio |
Current value |
|
P/E using 5-year average adjusted earnings per share |
11.1 |
|
2-year average forecast P/E |
12.0 |
Source: Company reports, consensus forecasts
On the face of it, BAE looks very reasonably priced, especially given its 4.4% prospective yield.
However, BAE has been struggling to grow in recent years, thanks mainly to budget cutbacks in the UK and US the firms two biggest markets.
Is BAE cheap because its a business thats stagnating or shrinking?
Fundamental shrinkage
A closer look at BAEs accounts from the last five years suggests that BAEs business may indeed be shrinking slightly:
|
5-year compound average growth rate |
Value |
|
Sales |
-3.6% |
|
Underlying earnings |
-2.6% |
|
Underlying earnings per share |
1.4% |
|
Dividend |
+4.7% |
Source: Company reports
Annual turnover has fallen by an average of 3.6% per year since 2009, while underlying earnings (defined by the firm as earnings before interest, taxation and amortisation, or EBITA), have fallen by an average of 2.6% per year over the same period.
Investors have been consoled with dividend growth averaging 4.7% per year, but the apparent annual growth in the firms underlying earnings per share should be treated with caution: it contradicts BAEs falling profits, and is mainly the result of the companys ongoing share buyback programme, which totalled 212m in 2013 alone.
Uncertain outlook
I dont think BAEs problems are bad enough to warrant selling the stock, but I only rate it as a hold at present, not a buy.
One of my concerns is that City consensus forecasts for the firms earnings have been downgraded steadily this year: the current forecast, for earnings per share of 37.6p in 2014, is almost 5% lower than it was just three months ago.
In my view, BAEs shrinking sales and profits are a warning that the current share price might not be as cheap as it seems. I believe it might pay to wait a little longer, before buying any more of the firms shares.
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Roland Headowns shares in BAE Systems. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
