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Has BAE Systems cleared the decks with its pensions top up?

The defence contractor, which last month agreed to spend US$2.2bn on a pair of acquisitions, said its total pensions deficit was £1.9bn

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BAE Systems PLC (LON:BA.) is clearing the decks faster than planned and offers scope for free cash flow to sail higher, analysts said.

The City was mostly positive about the defence contractor's agreement to make a debt-funded £1bn payment in the coming months after consolidating six of the nine schemes in order to clear up its complex liabilities. 

BAE, which last month agreed to spend US$2.2bn on a pair of acquisitions, said its total pensions deficit was £1.9bn, as of the end of last October.

UBS analysts noted that BAE is expecting to generate free cash flow of around £1bn in 2020 and in excess of £3.5-3.8bn over 2020-22.

With £1bn to top up pension underfunding, on top of top-ups of circa £240m in 2020 and £250m next year, beyond 2021 these top-ups will end as the scheme will be 92% funded.

"This should then ease pension trustees 'control' on use of excess cash," UBS said.

Sophie Lund-Yates, analyst at Hargreaves Lansdown, said it "means the decks are being cleared faster than originally planned, and there’s scope for free cash flow to sail higher from 2022”.

However, it was noted elsewhere that BAE's underlying pension liabilities including the US are almost £30bn, which eclipses the group's £21bn market valuation.

Independent pensions experts John Ralfe told the Times newspaper that BAE is "doing the right thing" with its new recovery plan but the size of its total underlying pension liabilities means the company is not out of the woods, especially as unlike other some companies have done, it has not closed its defined benefit scheme to existing members, meaning its pension liabilities are continuing to increase.

Financial results

The FTSE 100 defence contractor’s results showed growth in all divisions but its smallest division, Cyber & Intelligence.

With underlying sales up 7% to £20.1bn and underlying profits (EBITA) up 5% to £2.1bn, Lund-Yates said the company was making high while the sun shines on US defence spending.

“The Trump administration loosened defence purse strings, and BAE has been able to capitalise on the trend, with increasing volumes of things like US combat vehicles bolstering order backlogs,” she said.

For the 2020 fiscal year, BAE noted that the US has a top line budget of US$738bn for defence, a 3% increase over 2019, and lawmakers have already agreed to a bipartisan deal setting the defence spending caps for fiscal year 2021 at US$740.5bn. 

“Whilst the group remains cautiously optimistic about the budget process, numerous ongoing political issues may continue to detract from the timely passage of appropriations legislation,” the company said.

While the UK government is expected to launch an integrated foreign policy, defence and security review during the course of 2020, Lund-Yates said “things are a little less clear” when it comes to the provisional sale of 48 Typhoon fighter jets to Saudi Arabia. 

“Lingering political tension means it’s not yet a case of all systems go for this £10bn transaction, and the deal is something BAE will be keen to land at some point.”

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