BAE Q3 – Q4 2020 Market Report Analysis

BAE Systems Overview

BAE systems is a British defence company based in London. The company currently has a staff of 85,000 employees with facilities in 40 countries. Charles Woodburn currently occupies the CEO position under the direction of BAE’s board of directors led by Sir Roger Carr. BAE systems is the result of a 1990s trend towards building large European defence companies through mergers, in parallel with an identical American defence sector trend. BAE systems produces across the land, maritime and aviation sectors. BAE’s customers mainly reside in the US, Australia and Middle East regions. BAE’s engagement in the European sphere is limited encompassing a 33% share in the Eurofighter GmbH and a 2019 joint-venture with Germany’s Rheinmetall Group called Rheinmetall BAE Systems Land. Eurofighter GmbH guides the manufacture and sale of the pan-European Eurofighter Typhoon project and Rheintmetall-BAE Systems Land focuses on the UK based production of armoured vehicles.

BAE’s land component is currently contracting extensively with partners primarily in the United States and the UK. The land component wholly or partly produces the US Army’s M2/M3 Bradley IFV, M113 APC, M109 155mm Paladin self-propelled howitzer, M777 155mm Howitzer and the British Army’s Challenger II MBTs and Warrior Tracked Armoured Vehicles. The company’s maritime component produces the Royal Navy’s most potent warships often gaining first bidding rights for British military vessels. BAE’s shipyards currently produce the Astute class nuclear submarines, the future Type 26 frigate class and the Queen Elizabeth class aircraft carrier series. BAE Aviation is currently heavily involved in both the US’s F-35 II Lightening fighter jet programme and the pan -European Eurofighter Typhoon project.

Report Introduction

The 11th of November 2020 saw BAE release its market update for the second half of 2020. The second half of the year is taken to mean Q3 – Q4. The events for December 2020 are not included in this update, only encompassing everything up to early November. The market update is not a quarterly report and is significantly shorter. The market update is split into two sections, a market update and an operational update. The market update provides an overview of BAE’s relationship status with its current clients. The operational update provides a progress reports on current BAE contracts. The European and Oceanian marketplaces are featured primarily, the US and the Middle East are mentioned sparingly. The company reports that the overall impact of Covid-19 has been minimal with ‘well over’ 90% showing up i.e. 90 – 97%. The information presented in BAE’s report and in this analysis of that said report is accurate up to the date of the 11/11/2020 publication of BAE’s market update. The market update can be found here:

https://www.baesystems.com/en/article/market-update-november-2020

Charles Woodburn CEO of BAE made the following statement regarding the performance of BAE during Q3 – Q4 2020.

Charles Woodburn CEO

“We have continued to deliver a resilient performance in line with our expectations for a strong second half, thanks to the outstanding efforts of our employees in these challenging times. From a position of strength, the actions we took in quarter two to enhance our resilience are working well as reflected in our guidance, ensuring we continue to deliver on our customer priorities, whilst keeping our employees safe. Demand for our capabilities remains high and we recognise our role not only in supporting national security, but also in contributing to the economies of the countries in which we operate.”

Charles Woodburn CEO

Market Update: General Performance & Sector Report Q3 – 4 2020

General Marketplace Performance

The tone of Mr. Woodburn’s statement regarding the company’s performance is laced with enthusiasm for BAE’s ability to maintain its strong performance for 2020. The statement’s tone is accurate as to the current realities of BAE’s potency within the defence sector. The sales and cash flow for the company has been higher than that expected. The report highlights the profit boosting effect of acquiring a low tax rate for 2020, which enabled it to negate particularly wild currency fluctuations due to COVID-19. The emergence of COVID-19 and the drastic reactions of governments, entailing widespread economic restrictions, have gravely impacted most actors in the defence sphere. The worst hit companies have been those, like Raytheon (whose Q3 Report can be accessed on our site), who straddled the line between the civilian and military sectors. BAE has bucked this general negative economic trend, experiencing a greater volume of orders than those forecast pre-COVID. The company reportedly holds a large backlog on orders with a continuing order flow. The situation in the US marketplace is amenable for BAE with $740bn of defence spending authorized by Congress for 2021. BAE is also currently managing a US backlog which will see it armed with consistent work in the sector.

Client Sector I: Europe

The European client sector is not a sector in which BAE is significantly invested. The company overview at the top of this document, alluded to BAE’s significant stake in the Eurofighter programme and a new joint-venture with the Rheinmetall group. BAE’s stakes within Eurofighter GmbH and Rheinmetall BAE Land Systems puts them in a position to enter Germany’s re-militarization market trend. The trend is formed by a significant uptake in defence contracting coming out of Germany, with seven major contracts across the Bundeswher, Deutche Marine and Luftwaffe since August 2020. The market trend appears to have been set in motion by the removal of Ursula von der Leyen as defence minister. Mrs. Von der Leyen’s replacement, Saarland CDU politician, Annegret Kramp Karrenbauer, is seemingly determined to bring the German armed forces back into its role as a central NATO partner.

BAE’s stakes within Eurofighter GmbH and Rheinmetall BAE Land Systems puts them in a position to enter Germany’s re-militarization market trend.

Mrs. Kramp Karrenbauer’s tenure has already seen a stop put to German military decline, a decline made all too obvious by the sight of the Bundeswehr being deployed to NATO’s 2014 games carrying boomsticks in lieu of rifles. The defence minister’s efforts to turn the German Armed Forces around has paid off with the replacement of the poorly performing G36 assault rifle, the delivery of SAAB’s RBS15 Mk 3 anti-ship missiles to the Deutsche Marine and the modernization of the Luftwaffe’s decaying CH-47 heavy-lift helicopters. The minister’s procurement achievements in such a short space of time are impressive and Q4 2020 has seen Mrs. Kramp Karrenbauer turn her sights to the Eurofighter programme. BAE is now actively involved in their first German re-armament project as of November 2020. BAE’s involvement is through Eurofighter GmbH, a company which it partly owns via its 33% shareholding. The contract will see the company replace the Tranche 1 Eurofighters with 38 state of the art Tranche 4 Eurofighters. The market update decalres that the contract has been a significant player in returning unexpectedly high revenues for BAE during Q3 – Q4 2020.

Eurofighter Typhoons at Sunset

BAE’s only other European commitment remains its commitment to the British Government. The company outlook for the UK is stable. The firm has identified the two sources of UK defence market stability. The first being the UK’s renewed commitment to NATO’s 2% of GDP defence spending target and the continuation of the UK’s Integrated Foreign Policy, Defence and Security Review 2020. The review focuses on identifying current and future challenges to UK sovereignty and military capability. A consistent source of concern for many UK market operators since 2016 has been attempting to guess the result and potential impact of Brexit. BAE does not predict Brexit having a considerable effect on its current UK operations. BAE reasons the lack of impact will be due to the small amount of business done in Europe in comparison to that done in the UK, combined with the vast majority of BAE staff being British nationals.

Client Sector II: Oceania

Q3 – Q4 2020 has seen continued activity with the Australian government, forming BAE’s chief partner in Oceania. BAE is currently the primary defence contractor in the Australian market, this position is expected to grow in parallel with Australian government investment in the defence sphere. The Australian government is expected to increase its current $195bn AUD investment up to $270bn AUD in the coming year. Investment increases of this nature are expected over the course of the next decade. The likelihood of the renewal of this investment at the end of the 2020s is unclear. The renewal of any government investment project post-current project would not necessarily increase the monetary value of the investment. BAE’s position as Australia’s defence market leader, puts it ahead to exploit this public sector investment. The most notable project currently executed by BAE in Australia is the construction of eight Hunter-class frigates for the Royal Australian Navy.

The successful prosecution of the Hunter-class frigate project will likely result in an improved reputation among Australian government clients for BAE

The Hunter-class frigate programme is the project to replace the Australian and New Zealand Royal Navies current Anzac-class frigates. The Hunter-class programme is the product of a 2009 policy paper published under the first Rudd administration (2007 – 2010). The policy paper advised the procurement of eight new class future proofed frigates to replace the 20th Century Anzac-class frigates. The contract to construct the Hunter-class went to BAE after a 2016/2017 tendering process. BAE’s selection lead to the adoption of the Type 26 Global Combat Ship to form the Hunter-class frigate’s base model. The company sees the continuation of this programme as key to its ability to maintain is premier position within the market. The successful prosecution of the Hunter-class frigate project will also likely result in an improved reputation among Australian government clients for BAE. The enhanced reputation could advance BAE’s ability to lead more projects for the Australian government down the line and a potential position as the Australian military’s ‘go-to’ producer.

Operational Update: Ongoing Contract Execution

Project Tempest

Project Tempest is an Anglo-Italian project involving government and private sector partners to produce a sixth-generation jet fighter. The public sector participants in the project are the Royal Air Force, Italian Air Force and MoD. The private sector participants are BAE, Rolls-Royce and Italian firm, Leonardo S.p.A and multi-national firm, MBDA in which BAE has a 37% stake. The inclusion of Leonardo S.p.A. With a particular penchant for avionics, Rolls-Royce’s specialities in engine construction, MBDA’s missile construction expertise and BAE’s learned skills from the Eurofighter project will combine to allow the whole craft to be built within the project. The inclusion of a Swedish firm seems to be incoming and July 2020 saw a further expansion of partners namely; General Electric UK, GKN, Raytheon’s Collins Aerospace, Martin Baker, QinetiQ, Bombardier and Thales UK.

The potential of a partner nation walk-out akin to France’s 1985 Eurofighter walkout, should be recognized.

The project contains two definite risks. The first risk to the Tempest Project comes from potentially including too many private sector actors to maintain project vision and cohesion. The risk, if it materializes, is likely to result in a ballooning of project costs as competing ideas attempt to gain prominence. The greater current risk to the programme however, lies in the public sector. The public sector partners each come with their own significant political baggage from London and Rome respectively. The potential of a partner nation walk-out akin to France’s 1985 Eurofighter walkout, should be recognized. The British government is currently expected to inject two billion pounds into the project, across a five year period i.e. 2020 – 2025. BAE’s reporting on the project’s progress indicates it’s continuing as expected. The reported movement towards a trilateral MOU between Italian, British and Swedish defence companies, has seen the project move forward in Q3 – Q4 2020.

USMC Amphibious Combat Vehicle Programme

SuperAV Amphibious Combat Vehicle

The United States Marine Corps Amphibious Combat Vehicle programme, seeks to produce a new amphibious assault vehicle for the USMC. The project is a successor to the Expeditionary Fighting Vehicle (EFV) programme cancelled in 2011. The first financial quarter of 2011 saw a design request issued for a rapid water-to-ground platform, capable of high water speeds and coordination with M1A1 Abrams MBTs. The vehicle which would also need to be able to self-deploy from amphibious assault-ships. BAE’s involvement with the project came in Q4 2015 as the company’s SuperAV vehicle was selected for the final phase of the selection programme. BAE’s entry beat SIAC’s Terrex ICV and in 2018 the SuperAV was confirmed as the USMC’s new amphibious combat vehicle. The SuperAV is the result of a 2011 collaboration agreement between BAE and Italian firm Iveco. The end of Q3 2020 reportedly saw the SuperAV pass initial operational test and evaluation with the USMC. The results advance the speed of movement from Low Rate Initial Production (LRIP) levels of SuperAV construction for testing purposes, over to full rate production for sale purposes.

Joint Strike Fighter F-35 Lightning II Programme

F-35A Lightning II Joint Strike Fighter

BAE is currently involved in the development of the F-35 Lightning II via its inclusion in the Joint Strike Fighter project. The Joint Strike Fighter (JSF), is a development programme to design and produce a single aircraft encompassing fighter, strike and ground attack roles. The programme began in earnest in 1993 and in 1996 the British government became invested in the programme, looking for a replacement for the 1980 Sea Harrier. Lockheed Martin’s presentation of the X-35 saw the firm become the lead contractor using the X-35 base to develop the F-35 Lightning II. BAE entered the project in 1997 alongside Northrop Grumman, to work under Lockheed Martin’s direction. The evolution of the F-35 out of Lockheed Martin’s X-35 prototype saw BAE systems role within the project defined. The defined role is that of providing missions systems and airframe components for the craft. BAE reports that the work on the F-35 programme has increased in the area of electronic systems. The performance in this project has been deemed by BAE to be strong, with work on the programme deemed to be making good progress on reducing the backlog in orders relating to the F-35.

Qatari Eurofighter Typhoon & Hawk Procurement Contract

BAE Hawk Advanced Trainer

BAE is currently providing Eurofighter Typhoon multi-role fighter jets and BAE Hawk advanced jet trainer aircraft to the Qatari Air Force. The jet provision contract also comes with after-market training and support services. The quantity of products was confirmed at the end of Q3 2017 with the signature of a statement of intention to procure 24 Eurofighter units. The end of Q4 2017 brought the deal to official status with a confirmation announcement from Doha by British and Qatari government ministers. The contract was legally confirmed through the end of Q3 payment on the contract. The contract is expected to deliver its products by an unspecified predicted date in 2022. The report highlights that the work on this contract continues ‘well’, taken to mean in line with company expectations.

Royal Navy Offshore Patrol Vessel Procurement Contract

BAE has been involved in the provision of Offshore Patrol Vessels to the Royal Navy since Q4 2013. Q3 2014 saw BAE officially contract with the Royal Navy to construct three OPV’s, HMS Forth, HMS Medway and HMS Trent. The contract was signed for £348 million in mid-Q3 2014 and included after-market services. BAE has been executing the OPV contract through its riverside shipyards on the Clyde in Lanarkshire. The completion of the original contract led to a follow up contract as a result of the Strategic Defence and Security Review 2015. The follow up contract comprised a £287 million order announced at the end of Q4 2016, for two more OPVs of the same class. BAE is currently executing this second contract. The first vessel, HMS Tamar is currently in its training phase in Portsmouth. The market update reports that the second vessel, HMS Spey was delivered to the Royal Navy in early Q4 2020.

BAE Company Updates

  • BAE has merged the Airborne Tactical Radio and Military GPS businesses into their electronics systems division. The merger is reportedly progressing well and both businesses are said to be performing as expected.
  • In mid-Q4 2020 i.e. November the Cyber security company Silversky was removed from BAE.

The market update for BAE during Q3 – Q4, leaves an impression of a company well prepared for what is likely to be an economically difficult 2021

Report Summary

The market update for BAE during Q3 – Q4, leaves an impression of a company well prepared for what is likely to be an economically difficult 2021. The company is in a surprisingly strong position given disruption to the global economy, caused by governmental responses to Covid-19 mainly affecting employee turnout and the financial markets. The serious fluctuations in currency valuations have been adapted to with excellent alacrity by BAE. Employee turnout has remained at above 90% and the receival of higher order numbers than expected in its pre-Covid forecasts, leads to a company well fortified for potential crises in 2021. The company’s impressive order backlogs across its client sectors contribute to this fortified picture, likely to continue for some time to come. BAE will present its full year financial results in mid Q1 of 2021.

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