Morningstar | BAESY Updated Forecasts and Estimates from 17 Jun 2019
Narrow-moat BAE Systems reported mixed 2018 results, roughly in line at the group level but with some divisional underperformance on margins. We are maintaining our GBX 630 and $33 fair value estimates for the local and ADR shares, respectively.Electronic systems, with the highest division margins and contributing 30%-plus of group cash flow, delivered in-line results and its steady performance should continue in 2019 with 70% of revenue in the order backlog. The division, which provides electronic warfare systems (for example, the use of radar to disrupt or deceive an enemy's own radar), produces relatively stable EBIT margins versus historical performance as well as the other divisions. During 2018, it expanded operations in the U.S. with two new facilities and secured a close to $400 million contract for laser-guided rockets. The division's classified work also expanded to 11% of revenue.
The air division, BAE's largest cash flow contributor with 50% or more of group cash flow, posted good results with its EBIT margin at the top end of the 11%-13% guidance. However, this includes a temporary benefit of around 70 basis points from the Oman Typhoon completion. Therefore, division margins in 2019 should be lower as they will not include this benefit. Adding in the mix effect from earlier-stage (lower-margin) revenue from the Qatar Typhoon and Hawk programmes, fighter jets and training aircraft, means that the EBIT margin could be more than 100 basis points lower in 2019.
The maritime division's profitability was lower than guidance with higher-than-expected costs on its aircraft carrier program. 2019 should therefore see some modest improvement in the EBIT margin as it will not include the charges made in 2018. Also, having 95% of 2018 expected revenue already booked in the order backlog clearly provides less risk of a negative margin surprise relative to guidance, which indicates a 2019 EBIT margin of 8%-9%, up from the 7% reported in 2018.
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