Is BAE Systems an Exciting Emerging Market Play?

LONDON -- While crippling austerity in Europe and fiscal obstacles could put the brake on growth rates there, in developing regions a backdrop of accommodative central bank action, elevated commodity prices and rising personal affluence levels have created an environment of exceptional commercial opportunity.

The divergence between the growth prospects of traditional and developing markets is borne out by latest International Monetary Fund's (IMF) growth projections, which expects developing nations and emerging markets to expand 5.3% and 5.7% in 2013 and 2014 respectively. By comparison, it anticipates that the U.S. economy will rise 1.9% this year and 3% in 2014, while eurozone GDP is forecast to dip 0.3% in 2013 before rebounding just 1.1% next year.

Bubbly activity in these developing geographies can create large opportunities for many London-listed firms. Today, I am looking at BAE Systems  and assessing whether their operations in these regions are likely to underpin solid earnings growth.

Emerging market orders ignite in 2012
BAE Systems announced in February that group sales dipped 7% in 2012 to £17.8 billion, a result which drove profits before tax 7% to the downside, to £1.7 billion.

The company has suffered the impact of falling defense spending in the West, as operations in Iraq and Afghanistan have wound down and heavy budget cuts weigh. The U.S. represents more than 40% of company sales, and the effect of sequestration across the Atlantic continues to cast a pall over BAE Systems' revenues outlook. Even so, the company still remains an important supplier to the U.S., and just this week inked an $80 million deal with the Navy for maintenance work its submarine fleet's weapon systems.

Even so, the defense specialists are ramping up activity in new geographies to mitigate the potential for further weakness in traditional markets, and saw orders from outside the U.S. and U.K. balloon 133% to £11.2 billion last year. This drove the firm's total order backlog to £42.4 billion, up 8% from 2011 levels.

The company is already an established player in Saudi Arabia and Australia, and has recently latched onto the lucrative Indian marketplace in its move to boost its pan-global presence. In particular, BAE Systems is a major hardware and support provider to the Saudi Kingdom's Air Force and Navy -- Typhoon aircraft deliveries are to resume this year, and the company has orders worth £3.4 billion for support services set to run through to 2016.

So is BAE Systems a buy?
Broker Investec expects earnings per share to increase 11% this year to 43.2 pence, before edging 1% higher in the following 12 months to 43.7 pence.

The company is a favored pick among investors seeking huge dividends. The company is tipped by Investec to increase last year's full-year payout of 19.5 pence per share to 21.7 pence per share and 21.9 pence per share in 2013 and 2014, correspondingly. These provide a yield of 5.8%, soaring above an average prospective yield of 2.6% for the aerospace and defense sector, and 3.3% for the FTSE 100.

As well, these dividends are well protected with coverage of two times forward earnings for both this year and next, bang on the safety benchmark and in line with the company's strategy, providing investors with peace of mind even if earnings come under pressure.

BAE Systems was recently trading on a P/E rating of 8.7 and 8.6 for 2013 and 2014, respectively, symbolizing a meaty discount from a forward earnings multiple of 11.7 for the whole aerospace and defense sector.

In my opinion, the prospect of chunky dividends, supplemented by the firm's three-year, £1 billion share repurchase program started in February, makes the company a delectable pick for income investors. And I believe that rising activity in new regions should underpin earnings expansion and consequently dividend growth.

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