BAE Systems undervalued in face of much improved growth outlook - Berenberg

BAE Systems shares are not fully reflecting the defence contractor's "much improved" growth outlook and supportive defence market, said Berenberg as it upgraded them to a 'buy' recommendation.

The investment bank expects growth to rebound and a re-rating for the shares, which have often traded at a discount to peers amid anaemic earnings growth in recent year, negative sentiment around its core Eurofighter programme, and a weak UK defence outlook.

"BAE’s growth outlook is now much improved and the defence market remains supportive, factors that are not reflected in the current valuation, in our view," said Berenberg, where analyst Andrew Gollan has taken over coverage.

"We expect the shares to outperform over the next year driven by a higher rating on this stronger growth profile," he said.

Updating his forecasts resulted in upping the price target to 700p from 600p for shares that have fallen 3% over 12 months compared to the 9% gain for the pan-European sector and 44% surge for US defence peers.

Gollan estimated circa 75% of group revenues will be in growth mode from 2019, underpinned by key programmes, and margin expansion of close to 70 basis points over the next five years due to a change in product mix from the strong growth in electronic systems and improvement in other segments such as US platforms & services and cyber & intelligence.

A four-year EPS compound annual growth rate of 7% is forecast through to 2022 compared to a five-year historical rate of 2%.