BAE Annus Horribilis Capped by Earnings Missing Targets

BAE Systems Plc, Europe’s largest arms maker, is set to report an earnings drop for 2012, capping a year marred by missed profit targets and a failed merger with the parent company of Airbus SAS.

Net income probably fell to 1.14 billion pounds ($1.76 billion) from 1.24 billion pounds, according to analysts surveyed by Bloomberg. Sales at the London-based company rose to

18.9 billion pounds from 17.7 billion pounds, the survey found.

BAE unveiled merger talks with Airbus parent European Aeronautic, Defence & Space Co. in September, only to see the plans crumble a month later when governments denied backing. The companies had sought to link up to help ride out cycles in the civil aviation and defense industries, as BAE grapples with declining defense spending in Europe and the U.S., a market that EADS in turn had sought to penetrate.

“BAE is now in a transition year,” said Nick Cunningham, London-based analyst at Agency Partners. “Because the company’s land systems business has taken such a huge hit and in the U.K. the business is stabilizing or even growing, 2013 may feel better.”

The merger plan was unpopular with BAE investors, who openly opposed the deal out of concern it would water down dividend payments, the defense portfolio and add government interference from continental Europe. BAE further irked shareholders in December when the company said full-year targets were at risk as it struggled to wrap up a fighter-jet sale to Saudi Arabia.

Powering Ahead

Chief Executive Officer Ian King told employees in a memo that 2012 was “a challenging year both in terms of the economic environment in which we are operating and the merger discussions we held with EADS.” Even so, he said “far from being distracted by the merger negotiations, we powered ahead on all cylinders.”

BAE gained slightly in London trading. The shares advanced

0.5 percent to 331.6 pence by 8.47 a.m., the highest since Feb. 11, valuing the business at 10.8 billion pounds.

BAE gained 18 percent last year, its best annual performance since 2005, as it recouped the loss on the share price during the monthlong public merger deliberations. This year the stock has dropped 2 percent. EADS, based in Toulouse in southern France, has advanced 21 percent so far this year.

New Chairman

The U.K. company is moving to replace chairman Dick Olver, who has been a central executive figure since joining in 2004. Invesco Ltd., which holds a 13.4 percent stake, called on Olver to quit over the EADS merger, a combination the investor opposed. Olver, whose term expires in May 2014, may leave early if a replacement is found. Nick Rose was named as independent director in November to lead the search for a new chairman.

To improve competitiveness as its domestic markets shrink, BAE has cut costs and overhauled operations, including at its Detica cyber unit and its Land & Armaments business. Additional moves are planned, including a pending decision to shutter one of three U.K. shipyards.

Earnings may rebound as much as 15 percent this year, Deutsche Bank analyst Ben Fidler estimates. Investors may benefit from a share buyback only later this year, given the Saudi cash payment is still pending and BAE faces near-term U.S. spending reductions under the automatic budget cut known as sequestration, said Edward Stacey, London-based analyst at Espirito Santo Investment Bank.

Cutting Jobs

To mitigate the impact of falling sales in its traditional markets, BAE has been trying to win export deals in the Middle East and Asia. Oman agreed to buy 12 Eurofighter Typhoons and eight Hawk 128 trainer aircraft in December for $4 billion.

Saudi Arabia also renewed a long-term support agreement valued at about 5 billion pounds and a training aircraft deal valued at 1.5 billion pounds. King told employees the company beat the 2011 order intake from customers other than the U.S. and U.K.

The profit miss last year hinged on BAE’s failure to agree price escalation terms in the so-called Salam program under which BAE has delivered 24 of 72 Typhoons ordered as part of the government-to-government contract between the U.K. and Saudi Arabia. Deliveries of additional jets will resume this year. BAE builds the fighter in cooperation with EADS and Finmeccanica SpA.

Securing additional Typhoon sales, including in Malaysia, remains on BAE’s agenda. The company is also working with the U.K. government to sell the planes to the United Arab Emirates and both continue to push the Typhoon with the Indian government should negotiation stall with Dassault Aviation SA over the purchase of the Rafale fighters.

U.K. Prime Minister David Cameron was in India this week to help bolster exports. BAE also expects to finalize an export order of M777 howitzers to India soon.

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