Our target price of 2,192p is based on a DCF-derived fair value EV/EBIT multiple of 22x applied to our 2024 EBIT forecast. We derive our fair value multiple based on a 7.7% EBIT CAGR over 2025-30E, then 9% for years 6-10 as defense budgets accelerate, 3% growth in perpetuity and 9% WACC, and 100% long-term operating cash conversion. In deriving our equity value from our EV, we adjust for net debt and pension underfunding (post tax).

The key upside risks to our investment thesis on BAE Systems are: (1) US and European defence budgets continue to grow with increasing global threat levels; and (2) Large export contract wins.

The key downside risks to our investment thesis are: (1) An end to armed conflict in Eastern Europe may cause sentiment to move against defense stocks; and (2) UK/US budgets come under pressure, forcing material cuts to defence spending.

If any of these risk factors has a greater downside impact than we anticipate, the share price will likely have difficulty attaining our target price. Conversely, if the impact of any of these upside risks is greater than we anticipate, the stock could exceed our target price.