Shares in FTSE 100 defence group BAE Systems (LSE: BA) have soared in 2022, hitting all-time highs. The company has been the top performer in the lead index over the last year.
Unfortunately, there are no prizes for guessing what’s triggered this rise. Investors have been buying the stock in the expectation that the war in Ukraine will lead to an increase in defence spending by Western governments.
A market-beating profit
BAE’s share price has risen by 43% to 785p over the last 12 months. If I’d invested £1,000 in BAE shares a year ago, they’d be worth £1,430 today.
I’d also have received around £45 of dividend income, giving me a useful 4.5% dividend yield.
Overall, I’d have enjoyed a total return of about 48% in 12 months. By comparison, the FTSE 100 has delivered a total return (share price plus dividends) of around 8% over the last year.
That’s an impressive performance. But past performance is not a guide to future returns. Before I consider investing in this defence stock today, I need to consider whether BAE still offers value and can keep rising after such strong gains.
What’s the outlook?
I think it’s worth looking closely at recent comments made by chief executive Charles Woodburn. At the defence group’s AGM in May, Woodburn reported a “challenging operating environment in the near term”.
My guess is that this is a reference to well-known problems such as parts shortages, Covid disruption and rising costs.
Looking further ahead, he said diplomatically that he could “see opportunities to further enhance the medium-term outlook as our customers address the elevated threat environment”.
What this means for BAE investors
Woodburn is keen to emphasise that events in Ukraine won’t necessarily lead to an immediate increase in sales. From what I understand, most of the equipment supplied to Ukraine by Western countries has been taken from government stockpiles. Replenishing these will take time and won’t necessarily lead to significant new orders.
BAE says that order flow this year has been positive, but that the majority of orders being received are “long cycle in nature”. New business won this year is expected to support long-term growth, but isn’t likely to provide an immediate boost to profits.
Are BAE shares still cheap?
Although its profits can be uneven from year to year, the company’s numbers have trended steadily higher over the long term.
Shareholders who have stayed the course have benefited from one of the most reliable dividends in the FTSE 100 — BAE’s dividend hasn’t been cut for 30 years. However, BAE shares now trade on 15 times 2022 forecast earnings. That’s well above their long-term average of around 12 times earnings.
The expected dividend yield has fallen to 3.3% — below the FTSE 100 average of 3.6%.
I think there’s a risk the shares could underperform the market from current levels. I’m also aware that, historically, large defence orders have often taken longer than expected to be finalised.
Although I’m a fan of BAE as a long-term dividend investment, the shares look fully priced to me. I’m not convinced that now is a good time to buy, so I won’t be investing just yet.