BAE Systems has experienced a significant decline in its share price, dropping 15%. This is surprising given the positive outlook for the company’s future growth prospects toward 2026.
Understanding the Market Disconnect
Despite ongoing conversations about a potential peace deal in Ukraine, the fundamentals supporting BAE Systems remain robust. The key factor here is NATO’s commitment to substantially increase defense spending. This decision reflects a long-term strategy rather than a temporary wartime shift.
NATO Defense Spending Increase
In June, non-US NATO members agreed to elevate their defense budgets to 5% of gross domestic product (GDP) by 2035. This represents a significant rise from the previous 2%. The expected additional annual spending amounts to approximately $423 billion across these countries.
BAE Systems: Positioned for Growth
As Europe’s largest defense contractor and the world’s sixth-largest, BAE Systems stands to benefit from this increased investment. The company’s revenue streams are largely secure due to multi-year, legally-binding contracts.
Strong Financial Performance
- Half-Year 2025 Results:
- Sales rose 11% year-on-year to £14.6 billion.
- Earnings before interest and tax (EBIT) increased 13% to £1.55 billion.
- Basic earnings per share grew 11% to 34.7p.
- Record Order Intake:
- Order intake reached £13.2 billion.
- Total order book amounted to £75.4 billion, providing visibility for future revenues.
Analysts’ Expectations
Consensus among analysts indicates that BAE Systems’ earnings are projected to grow by 11.2% annually until the end of 2028. This growth forecast does not align with the market’s current pricing, which seems to suggest an impending decline in earnings.
Valuation Insights
Currently, shares of BAE Systems are trading at a forward price-to-earnings ratio of 23.5. This has dropped from 28.5 in June, indicating that the market is undervaluing the company.
Based on discounted cash flow analysis, BAE Systems shares are estimated to be undervalued by 28% at their current price of £17.50. The fair value is calculated to be around £24.31, indicating potential growth in asset prices over time.
Investment Outlook
BAE Systems is expected to maintain double-digit earnings growth through 2026, supported by a record order book and updated guidance. This positive outlook highlights the gap between market perception and the company’s actual growth trajectory.
Given these insights, now may be an opportune time to consider increasing holdings in BAE Systems. The structural changes in defense spending highlight an attractive investment opportunity for the future.
