BAE Systems rallies as UBS says it will benefit from higher US defence spending

Defence contractor BAE Systems rallied on Wednesday as UBS said the US defence budget blueprint supports US revenue growth acceleration.

"We think BAE is very well placed to benefit from an increase in US Army spending after eight years of cuts. BAE's valuation is attractive relative to US and European peers."

The bank noted that around 37% of the group's sales are exposed to US defence. UBS pointed out that the full-year 2018 base modernisation budget request came in 9% above FY17 levels and 4% above the bank's forecasts.

"This supports our view on the organic revenue and profit growth potential for BAE's US businesses. For 2019/2020ewe forecast 6%/7% organic revenue growth in Electronics and US Platforms - as typically there is an 18-24 month delay between enacted budget and industry revenue," the bank said, as it reiterated its 'buy' rating on the stock and 730p price target.

"BAE trades on 11.7x 2018E EV/EBITA versus its US defence peers on 16x and its European peers on 12.3x. Given BAE's geographical exposure and dividend yield, we think BAE should trade more aligned with the US/EU peers average," UBS said.

The bank reckons BAE can deliver a 6% free cash flow to sales in 2017, well above the sector average of 4%, which should support a re-rating of the stock.

Cobham was also among the companies UBS reckons could benefit from further spending increases in the US, as it generates around 34% of its revenues from US defence and security, with around 75% air, 15% naval and 10% army exposure.

At 1230 BST, the shares were up 2.8% to 659.68p.