The share price of BAE Systems, the British aerospace and defence company continued its recent positive trajectory with a 1% gain this week, which ended with the announcement of a new foray into electric passenger aeroplanes. The company has now seen its valuation rise over 14% since the beginning of the year and 37% over the last 12 months.

The announcement on the last day of March, detailing a partnership deal with the Swedish startup Heart Aerospace, will see BAE Systems return to a civil aerospace market it withdrew from in 2001. The collaboration will see the two companies work on the battery for Heart’s electric conventional takeoff and landing (eCTOL) regional aircraft, the ES-30.

It will be the first time such a battery has been integrated into a eCTOL and will allow the electric aircraft to efficiently operate with zero emissions and low noise.

The ES-30 will have four electric motors, an all-electric range of 200 km, an extended reserve hybrid range of 400 km with 30 passengers, and a range of up to 800 km with 25 passengers. The Swedish starup has 230 orders and 100 options for the aircraft and a letter of intent for another 108.

BAE shut down its civil aerospace programme after the 9/11 terrorist attacks on New York, anticipating a negative impact on the civil aviation market. It was last involved in the manufacture of civil aircraft in 2006 when Mike Turner, at the time the company’s CEO, sold a 20% stake in Airbus-predecessor EADS.

BAE has an increasingly strong-looking pipeline

In February, BAE upgraded its earnings outlook for 2023 on the basis of increased military spending by Western governments supporting Ukraine in its resistance to Russia’s early 2022 invasion of its territory. BAE builds a range of expensive military equipment including the Eurofighter Typhoon jets, combat vehicles and nuclear submarines.

BAE is also the British military’s main supplier of ammunition as well as a major supplier to other international armed forces, including the USA. It stands to benefit significantly from the historical volumes of ammunition currently being expended in Ukraine with Western governments already fearing supplies are running dangerously low.

The issue with ammunition production is that defence companies are wary of overinvesting in increased capacity that may not be needed in the long term. Lessons have been learned after companies made capacity investments at the height of the USA’s “War on Terror” that quickly became white elephants when the American and other armed forces subsequently cut back on military spending.

However, agreements including a new 15-year supply contract with the British Armed Forces and commitments made by other international buyers for guaranteed quantities of ammunition over the next decade are now being made. Those will provide the assurance needed for BAE and other defence contractors to again make capital investments in expanding capacity to meet current needs.

However, chief executive Charles Woodburn told investors that the record £37 billion in new orders that had taken its pipeline to a backlog value of £58.9 billion in late February mainly consisted of deals struck before the start of the war in Ukraine. The big change is expectations for future order values with Woodburn telling investors the company expects

“continued momentum in the medium to long term as governments replenish stocks, recapitalise equipment and support allies”.

2023 sales growth is expected to come in at between 3% and 5% and underlying earnings before interest and taxes to show improvement of between 4% and 6%.

Does the BAE share price still look attractive despite recent gains?

The BAE Systems share price has gained almost 150% since a recent low in late 2020 and has doubled in the past 2 years. Does that suggest the company’s strengthened orders pipeline has already been priced into its current valuation?

Barclays analysts are bullish that, based on BAE’s historical backlog to revenue conversion rate that has risen to an average of around 43% since 2018, the current pipeline means better future organic growth. A 45% backlog conversion in 2024 would add around £2 billion to BAE’s revenue and roughly £220 million to underlying profit, boosting earnings per share by up to 8%.

That’s ahead of the current market consensus and could mean more valuation growth ahead for BAE. The analysts also expect the company to spend around £1 billion a year on share buybacks over the next few years, which should further bolster the company’s valuation.

The bank has a current share price target for BAE of 1020p versus the current level of 978p, which would represent a 4% gain over the next year. Jefferies analysts are more bullish, setting a price target of 1060p, indicating faith that there could still be significant valuation gains to be picked up in the nearterm. A rise go 1060p would be a share price gain of over 8% in the current valuation.

BAE also offers dividends that represent a yield of around 2.8% on the current share price and are expected to rise with cashflow over the next couple of years at least. The 2023 payout is forecast to rise to 28.7p per share, which would take the dividend yield to almost 3%. And for 2024 and 2025, dividends of 31p and 33p are expected, taking yield up to around 3.6%.

That should be a relatively conservative forecast for dividend yield growth with dividend coverate of over two times based on predicted earnings over the next three years. In the worst case scenario of earnings disappointing, BAE has a strong balance sheet with its net debt to EBITDA ratio sitting at just 1.2 times at the end of last year. That should allow it to pick up any slack if earnings growth proves bumpier than anticipated.

Recent gains mean stellar growth unlikely but BAE still looks like a strong bet for solid growth

Investors who buy into BAE now probably can’t realistically expect any repeat of the returns earlier investors have benefitted from over the past couple of years. However, newly intensified geopolitical stresses, including the stand-off between China and the USA over the future of Taiwan, mean defence spending is expected to remain elevated until at least towards the end of the current decade.

The war in Ukraine is also looking unlikely to cool off this year, meaning huge amounts of ammunition will continue to have to be purchased by the country’s international coalition of supporters.

With all that in mind, BAE’s pipeline looks like it will continue to grow for the foreseeable future. A combination of strong revenue growth, share buybacks and growing dividends, as well as new potential revenue streams such as the deal with Heart Aerospace on electric aircraft, means BAE looks like a relatively safe bet in the medium term.

No investment is without risk and a sudden deeascalation in Ukraine and cooling of tensions over Taiwan would hurt BAE and other defence companies badly. However, based on current evidence and expectations, BAE looks like a solid opportunity for several years ahead, offering a very respectable and stable-looking dividend yield and capital appreciation potential.