Why Shares In BAE Systems plc Plummeted

BAE Systems plc (LON: BA) is the latest defence contractor to feel the hurt of government spending cuts.

Mark Stones

Mark Stones (TMFMumbojumbones) joined The Motley Fool in 2014 and initially worked as a writer for Fool.co.uk, before joining the Fool’s analyst programme. Mark earned a BA in English from Loughborough University. Although he spends more time reading annual reports than Russian literature these days, he still appreciates a novelist’s antipathy toward the accepted view, which is a useful attitude when trying to sniff out hidden gems on the stock market. His approach to investing has been largely influenced by the principles of Warren Buffett and Peter Lynch. He also takes a special interest in the work of healthcare companies. Outside of investing, Mark plays guitar, enjoys good writing and has a guilty passion for combat sports.

Published 20 February, 2014 10:12 am GMT

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Although we don’t believe in timing the market or panicking over every stock fluctuation, understanding how a business is performing, competing and changing is vital to sensible investment.

What: The share price of BAE Systems (LSE: BA) (NASDAQOTH: BAESY.US) tumbled sharply this morning, losing 10% to 390p during early trading, as revenues fell £700m below analyst forecasts. This was largely linked to a decrease in US government spending.

So what: Shareholders should have been prepared, given that fellow defence contractor Rolls-Royce lost £3bn in value last week, due to lower demand for defence equipment.

BAE’s pre-tax profit fell to £422m compared with £1.2bn in 2012, after an £887m impairment charge relating to its US Intelligence, Security and Land & Armaments businesses. The charge reflects an increase in BAE’s cost of capital and the aforementioned government cuts in defence spending.

Now what: The chief executive, Ian King, commented:

“We have started 2014 with good momentum with a settlement on Salam pricing, US budgets in place and a well-defined UK Maritime sector plan. Budget pressures in some of the Group’s larger markets are expected to prevail but BAE Systems has a broad-based portfolio. Our strong order backlog and robust balance sheet provide a solid basis for growth over the medium term.”

Continuing pressure on defence spending in the US, where BAE receives 44% of its revenue, could reduce earnings per share by 5-10% in the coming financial year, and profits could fall by up to 10% in 2014.

It was only yesterday that BAE added 15p to its share price, after a deal was settled with Saudi Arabia over the cost of 72 of BAE’s Eurofighter Typhoon jets. Things could have been worse, and there was even greater potential for a fall in earnings had these negotiations not been concluded.

Over the next few years Saudi Arabia is expected to be issuing more contracts, so its good news for shareholders that this longstanding relationship looks set to continue. Exports are crucial for BAE when it comes to driving growth.