Shares in BAE Systems PLC (LSE:BA.) have been downgraded to a ‘hold’ rating by Panmure Liberum, as concerns mount over looming cuts to the United States defence budget.
The aerospace and defence giant, which generates nearly half of its revenue from US government contracts, is bracing for potential reductions in spending on key military programmes.
According to the Washington Post, the United States administration is planning an eight per cent cut to the Department of Defense budget, with further reductions likely.
Defence spending is under pressure as the government looks for ways to fund an extension of tax cuts introduced in 2017.
With a significant portion of the federal budget already ring-fenced for social security, healthcare, and veterans’ benefits, defence is one of the few areas where cuts can be made.
Serious challenge
For BAE, this presents a serious challenge. The company is heavily reliant on United States military contracts, including programmes such as the F-35 fighter jet and armoured vehicle modernisation.
These are precisely the areas that could see reduced funding as priorities shift towards the Pacific and emerging technologies.
Panmure Liberum noted that while long-term contracts may provide some buffer, an eight per cent budget cut would be “inescapable” and likely to impact future revenue.
Despite these risks, Panmure Liberum has raised its one-year target price for BAE to 1,335p and its three-year target to 1,555p.
However, given that the current share price is already close to the new one-year target, analysts believe the risk to United States revenues makes the longer-term outlook uncertain.
First downgrade in more than seven years
As a result, they have opted to downgrade BAE for the first time since 2017, having previously maintained a ‘buy’ rating.
The change comes at a time when the broader defence sector has been enjoying strong demand.
BAE reported robust financial performance in 2024, with revenue reaching £28.3 billion, an increase of 12 per cent year-on-year. Free cash flow also remained healthy, despite some fluctuations in working capital.
However, with Washington signalling potential cuts, investors are now faced with fresh uncertainty over the sustainability of this growth.
In contrast to the administration’s stance, BAE’s United States management has expressed confidence that Congress will maintain or even increase defence spending.
Too optimistic
However, Panmure Liberum warned that this view now appears “optimistic” given the political and fiscal realities. The possibility of further delays in budget approvals due to political wrangling in Congress adds another layer of risk.
While BAE continues to have strong prospects outside the United States, including in the United Kingdom and Europe, the uncertainty surrounding its largest market has prompted a reassessment of its investment case. For now, investors may need to prepare for a more turbulent ride.
Since Wednesday’s Washington Post report, the stock has fallen around six per cent and is currently changing hands for 1,275p.
Images are for reference only.Images and contents gathered automatic from google or 3rd party sources.All rights on the images and contents are with their legal original owners.