July was a great month for BAE Systems (LSE: BA) shareholders. After largely mirroring the FTSE 100 from the start of 2021, the BAE share price took off around the middle of the month. In July alone, BAE gained 10%. That takes it to a gain of 18% year-to-date, compared to the Footsie’s 11%.
Investors appeared to be anticipating a good set of first-half results on 29 July. And that’s what we got. We saw a 21% increase in underlying EBIT compared to the first half of 2020. Underlying earnings per share grew by 25%, and free cash flow turned positive to the tune of £461m. Debt did swell by 35%. But at £2.7bn, it’s still only a fraction of first-half sales, and I’m not overly concerned.
With an order backlog of £44.6bn, the full-year outlook appears positive. Unlike so many other companies right now, we’re not looking at a weak previous year. No, despite the pandemic, BAE grew its earnings in 2020 to maintain its annual growth record of the past few years.
But since the start of August, the BAE share price has remained flat overall. So what’s happening? I can’t help wondering if the July spike was result of investors realising that BAE had been a bit neglected and was becoming increasingly good value. Maybe the market movers of the world poked around the company in advance of the results, and perhaps enough of them thought, “hang on, this is cheap“. The big question is, what’s going to happen now?
BAE share price valuation
In mid-July, BAE stock was on a trailing P/E of 11.4 based on 2020 earnings. Even now, after the subsequent gains, that multiple has only risen as far as 12.3. First-half underlying EPS of 21.9p would annualise to 43.8p if the second half doesn’t improve on it. That’s a little below last year’s figure, and would push the P/E up to 13.1.
There’s a risk that the market will consider BAE adequately valued now. After all, it’s close to the long-term FTSE 100 average, and at a time when the index as a whole is still looking a bit weak.
And though I’m not unduly concerned by BAE’s current debt level, if it started to creep higher then I think that could start to put pressure on the shares. So that will be my key lookout for the rest of the company’s financial year.
What will happen in H2?
What do I think the BAE share price will do for the remainder of August and beyond? I wouldn’t put much faith in my ability to guess. But I wouldn’t be surprised to see it remain flat for the rest of the month and year. And I suspect we might even see some falls as investors take a bit of profit off the table.
My final concern is BAE’s volatility. Over the past five years, the shares have lurched up and down, while barely beating the Footsie overall. BAE gained 8.7% while the Footsie is up 4.7%. But a couple of months ago, positions were reversed and the index was ahead.
Despite these drawbacks, though, I do rate BAE Systems as good value for the long term. If I buy, it will be with a minimum holding period of 10 years.