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The BAE Systems (LSE: BA) share price has put in a strong performance lately, rising 30% in the last year and 278% over five.
Yet that pales alongside the rocket-fuelled returns from two other FTSE 100 defence contractors. Babcock International Group (LSE: BAB) shares are up a stunning 134% over one year and 334% over five.
And that’s overshadowed by Rolls-Royce Holdings (LSE: RR.). It’s climbed 101% in a year and an astonishing 1,071% over five.
All three have been lifted by the same factor. The West has been reminded that we can’t take peace for granted. As Russia and China assert themselves, we need to invest in guns and ammunition again. Also aircraft carriers, submarines, fighter jets, helicopters and swarms of drones.
Rolls-Royce’s performance has an extra driver. While its defence division is growing, the civil jet engine business has surged thanks to the post-pandemic recovery in flying and the transformation led by CEO Tufan Erginbilgic since January 2023. The previous share price decline gave the company a springboard for resurgence.
Valuations and risks
The big question is what happens next. After such a spirited run, valuations look full, especially at Rolls-Royce. It now trades on a sky-high price-to-earnings ratio of 56.8, far above the FTSE 100 average of 18. BAE Systems has a more modest P/E of 26.3, while Babcock sits at 23.4. Cheaper, but still not cheap.
These numbers suggest the shares must keep performing strongly to justify current levels. A Longed-for peace breakthrough in Ukraine or détente with Russia could change the outlook quickly. Supply chain issues, technical problems or government spending restraint in Europe might hit all three at any time. Investing always carries risks.
Order books and future potential
Order books instill confidence though. BAE Systems has the biggest at £75.4bn, while Babcock’s £10.4bn is impressive for a £5.9bn company. Rolls-Royce’s defence division alone has an order backlog of £18.8bn. Solid pipelines support the potential for continued returns, although short-term fluctuations are inevitable.
I can’t shake the feeling that all three have run as far as they can for now. There are clear signs of a slowdown. The Babcock share price is down 4% in the last month, BAE Systems is down 9%. The Rolls-Royce share price has climbed but only by 1%.
Broker predictions back me up. Consensus forecasts point to Babcock gaining a modest 7.5% over the next year, taking the shares to 1,266p and turning £10,000 into £10,750. Rolls-Royce is forecast to rise just 4.6% to 1,206p, turning £10k in £10,460.
BAE Systems appears to have the brightest prospects, with a consensus target of 2,124p, up 18.5%. That would turn £10k into £11,850 if it happens. Dividends would be on top of these gains.
I’d be thrilled to see BAE Systems climb by the forecast amount, and it could happen given recent relative sluggishness. The shares remain well worth considering today. I’m more cautious about Babcock and Rolls-Royce at current levels. They’ve had a brilliant run, but could slow from here. All three are still worth looking at with a long-term view though. Sadly, I just can’t see global peace breaking out.
