Broker tips: BAE Systems, BT, Future

Berenberg upgraded defence contractor BAE Systems on Monday to ‘buy’ from ‘hold’ and lifted the price target to 1,170p from 1,050p.

The bank said the upgrade reflects "signs of a pivot in capital allocation towards strategic M&A, in addition to maintaining appropriate returns to shareholders, and our expectation that BAE will deliver a 10% EPS CAGR over 2023-27".

Berenberg said it was pleased to see signs of a pivot to pursuing strategic acquisitions. Over 2019-24, it forecasts that BAE will distribute 88% of its cumulative free cash flow to shareholders through dividends and share buybacks, the highest share among European peers.

"While we forecast that this share will remain at the upper end of the peer average (51%), the proposed $5.6bn acquisition of Ball Aerospace has signalled a greater willingness to pursue M&A, to open up new growth markets (in particular space).

"We think the medium-term financial outlook provided for Ball Aerospace is conservative, and also think further earnings accretive bolt-on acquisitions are likely, given the backdrop of steadily growing free cash flow over our forecast horizon."

In addition, the bank said that strong order intake is also increasing outer-year visibility and gives it confidence that we are entering a step-change in organic growth over the next five years.

"Against this backdrop, the shares offer good value, in our view, trading on 15.7x 2023 price-to-earnings for a 10% EPS CAGR over 2023-27."

In a separate note, Berenberg slashed its target price for telecoms giant BT by 10% and reiterated its 'hold' stance, highlighting five key reasons why investors should not invest just quite yet.

“Buy BT at GBP1 per share and sell it at GBP2': we have been hearing this rule of thumb a lot recently from investors, and while it feels oversimplistic, it does have a logic to it," Berenberg said.

Currently, the stock looks "cheap" as it is trading close to the low-end of its historic range at just seven times earnings, compared with the wider sector-average multiple of 13.

However, there are several reasons to be cautious, the broker said.

Firstly, there is a "heightened rebase risk" with a CEO transition occurring in January, along with further potential churn in the senior leadership team.

Berenberg said it is also concerned about the sustainability of BT's retail pricing model of "CPI+3.9%", given that the Labour Party (favourites to win the next general election) might take action on mid-contract price rises and challenge Openreach's CPI-linked price increases.

Meanwhile, the broker said that consensus forecasts for BT Business profits are currently too high, while consensus estimates for net debt remain too low.

Lastly, Berenberg said that BT's strategy to spend spare cash on fibre rollout means it doesn't have the money available to do share buybacks - unlike many other UK corporates right now that are taking advantage of current cheap valuations.

The target price has been cut from 150p to 135p for the stock.

Canaccord Genuity hiked its target price for Future but kept a 'hold' rating on the specialist media group, citing uncertainties around the strategy.

Shares surged by around 25% on Friday after a solid second-half trading update, which Canaccord put down to a lack of negative news and a depressed valuation.

"Therefore, the lack of negative news was always going to be taken very positively given the weak share price performance," it said. The stock was trading at just five times current-year earnings prior to the update after falling by a third by the start of the year.

Future's GoCompare unit performed well, which "could get bulls arguing material undervaluation", Canaccord said, given that listed competitor Moneysupermarket trades at a price-to-earnings multiple of 14.

However, GoCompare's strength was outweighed by weakness in the wider digital media division, with organic digital advertising and affiliate revenue declining in the second half.

The broker said: "In our view, it is too early to be bullish on Future given the uncertainties around the strategy of the new CEO and macro-economic environment, and our estimates are c.17% below consensus for FY24E profit before tax."

Canaccord raised its target from 757p to 827p for the stock, though that remains well below the current 895p price as of 1045 BST on Monday.