Berenberg downgrades BAE Systems, sees scant impact in case of Brexit

Analysts at Berenberg pared their earnings estimates for BAE Systems, while highlighting the risk that the debate surrounding the UK’s maritime defence budget might drive negative sentiment in the backhalf of 2016, which led them to downgrade their recommendation.

The June Defence Committee meeting had suggested potential slippage in the production phase of the Type 26 Combat Ship, although a later incremental award of £472m would likely bridge any initial impact of a production delay, the broker said.

Nonetheless, the possibility existed that the issue might drive negative sentiment towards the Aerospace and Defence contractor in the back-half of the year in so far as it fuelled concerns about an over-committed UK maritime budget.

In parallel, and following the company’s 2015 preliminaries, analysts Charlotte Keyworth, Andrew Gollan and Ross Law lowered their earnings estimates for the company in fiscal years 2016, 2017 and 2018 by between three to four percentage points.

As a result of all the above, the broker downgraded its recommendation on the shares from ‘buy’ to ‘hold’ and cut its target price from 570p to 520p.

On a more positive note, Berenberg called attention to the ‘good visibility’ on the company's sales, 45% of which came from support and services, with another 35% derived from major programmes, “providing revenue stability beyond our forecast horizon”.

Likewise, it believed the shares’ 25% discount versus its US defence peers on the basis of its fiscal year 2017 price-to-earnings multiple “looked unwarranted”.

Regarding the risks posed by Brexit, the analysts said any the impact would be “benign” given that less than 10.0% of the group’s sales came from within the European Union, nor did they see any negative fall-out on BAE’s trading with individual countries.

Weakness in cable would in fact help its export pricing especially vis-à-vis the Middle East.

The company’s level of gearing would not be an issue ahead of the interims nor the full-year financials despite 83% of its debt being dollar-denominated, Berenberg said.