BAE Systems’ (LSE: BA) share price lost 8% in two days after the 2 April US tariffs announcement. It has since recovered, which looks entirely justified to me.
It is true that nearly 50% of its global sales are in the US. But it is also the case that the firm has a major presence on the ground in the country. This means the vast bulk of its US sales come from products made there by BAE Systems. The same applies to much of the supply chain for its high-technology, high-security systems.
Indeed, BAE Systems told CityAM: “We have very limited imports into the US.” It added: “As such, we aren’t materially impacted by the evolution of US tariff policy in the same way that some other companies are.”
A long-term boost?
I believe that the most significant long-term effect of the tariffs announcement is not on trade. Instead, I think that its protectionist and isolationist stance underlines that the US’s NATO security allies cannot rely on its support anymore.
In this context, US President Donald Trump said on 7 March that: “If they don’t pay, I’m not going to defend them.” This specifically referred to European NATO members not spending a certain percentage of their gross domestic product on defence.
Trump has repeatedly made it clear in this second presidency that he sees 5% as the minimum acceptable spend. In 2024, European NATO members collectively averaged 2% of their combined GDP on defence, totalling $380bn (£296bn).
In response, a new €800bn (£670bn) pan-European defence fund was announced by the European Commission on 4 March.
Two weeks later, Germany voted to exempt its defence spending from its strict federal debt rules. This will free up unlimited billions of euros for spending by Germany both domestically and for the fund.
I believe BAE Systems will be a huge beneficiary of this spending as it is Europe’s biggest defence contractor and the world’s seventh-largest.
Is the core business in good shape?
A risk to the firm’s earnings is any major malfunction in any of its key products and systems. These would be costly to fix and could damage its reputation.
That said, consensus analysts’ forecasts are that BAE Systems’ earnings will increase 8.3% a year to end-2027.
And it is growth here that drives a company’s share price and dividend in the long run.
These projections look reasonable to me, with its 2024 results showing earnings jump 14% year on year to £3.015bn. Sales rose the same percentage to £28.335bn, while profit increased 4% to £2.685bn.
Crucially to me, its order backlog surged 11% to a record £77.8bn, including several milestone deals. These have continued, with 2 April seeing it awarded a $70m contract for the US Navy’s submarine fleet.
Is there value left in the shares?
I ran a discounted cash flow valuation to pinpoint where the stock’s price should be, centred on future cash flow forecasts for the firm.
This shows BAE Systems is 24% undervalued at its current £16.89 price.
Therefore, the fair value for the stock is £22.22, although market vagaries could move it lower or higher.
Given the changing global security outlook, the firm’s strong earnings projections and its undervaluation, I will buy more of the stock very shortly.
This post was originally published on Motley Fool
