Mounting geopolitical tensions have changed the game for BAE Systems
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Shares Magazine
Rising geopolitical tensions and expanding UK and European defence budgets following the Russia’s invasion of Ukraine have created a substantial tailwind for BAE Systems, with the shares delivering nearly 400% in total shareholder returns over the last five years data.
The shares have comfortably outperformed the FTSE 100 and the global defence sector. Before the invasion of Ukraine BAE shares traded on forecast PE (price to earnings) ratio of 12 times, less than half its current rating.
This implies that structural industry drivers have been increasingly recognised by the stock market.
Steepest increase in military spending since the Cold War
After the invasion of Ukraine global military spending increased almost 7% in 2023 to reach a record $2.44 trillion, followed by a further 11% increase to $2.72 trillion in 2024.
Adjusted for inflation the increase in 2024 was the largest annual increase since the Cold War. After struggling to meet the 2% of GDP target for years, NATO (North Atlantic Treaty Organisation) members have upped their game.
In Europe spending increased by 17% in 2024 and Germany’s budget leapt to $107 billion. A NATO summit in June 2025 saw allies commit to spending a minimum 3.5% of GDP on core military requirements by 2035.
An additional 1.5% of GDP is expected to be allocated to adjacent spending on cyber defence to protect critical infrastructure. In total, the new ‘gold standard’ for the NATO alliance could reach 5% of GDP over the next decade.
The UK’s Strategic Defence Review set a target to reach 3.5% of GDP by 2035.
The Trump administration has proposed an historic leap in defence spending to $1.5 trillion for 2027, an uplift of 50% on prior levels.
How is BAE Systems expected to benefit?
In February 2026 the company revealed record breaking sales of £30.7 billion and an order backlog which ballooned to £84.6 billion.
BAE is uniquely positioned due to its role as a key supplier to the AUKUS (Australia, UK, US) security pact.
The company is the world leader in electronic warfare suites for the F-35 Lightening II fighter, with allies expected to accelerate procurements in 2026.
A recent £4.6 billion deal to supply Turkey with 20 Eurofighter Typhoons which BAE co-produces has extended the life of the programme into the 2030s.
BAE supplies artillery and munitions to Europe and has seen an eightfold increase in productions to meet Ukraine and NATO replenishment needs since 2023.
The company makes the CV90 combat vehicle which saw a big increase in orders in late 2025 from Czech Republic, Sweden and Norway.
How does BAE’s generate sales and profits?
Roughly 90% of sales come from long-term government contracts with profits driven by high-margin aftermarket support and technology integration. The US remains the dominant market for BAE which was bolstered in 2025 by the full integration of the Ball Aerospace acquisition.
Despite only representing 12% of group sales, Europe was the standout performer in 2025, growing 26% driven by NATO members rebuilding defence readiness.
The Air division is the largest contributor to sales supported by the Typhoon programme and ongoing production of the F-35 fighter.
The Platforms and Services division continued to benefit from global stocking of munitions and heavy vehicle orders including a $1.7 billion funding boost for US combat vehicle production.
It is worth noting that the Maritime division, while not the largest by sales, represents a big proportion (over £30 billion) of the order backlog due to the multi-decade nature of building submarines and frigates.
Electronic Systems remain BAE’s most profitable area of business with the division achieving mid double-digit operating margins.
What should investors expect for 2026 and beyond?
Following record breaking 2025 results the company said it expects a deceleration in growth compared with the post-Ukraine surge, although overall sales growth is still expected to be in a range of 7% to 9%.
BAE guided for growth in underlying earnings before interest and tax of between 9% to 11% and more than £1.3 billion of free cash flow, which is lower than the £2.2 billion generated in 2025 due to timing of advances.
Looking further out BAE expects the conversion of its order backlog to drive steady revenue growth of between 8% and 12% a year through the rest of the decade.
Operating margins are anticipated to climb towards 12% as higher-margin segments like Space and Mission Systems become a larger percentage of the sales mix.
BAE expects to continue its policy of 10% annual dividend increases supported by a robust free cash flow target of more than £2.5 billion by 2028.
Peer group comparison
BAE trades at a premium to big US defence contractors which reflects rising European defence budgets as a percentage of GDP. European peer Rheinmetall trades at significant premium because it is the primary beneficiary of the rearmament of Europe.
While BAE’s focus is on long-cycle assets like nuclear submarines Rheinmetall makes ammunition and Leopard tanks which have seen significant demand since the invasion of Ukraine.
As a case in point, Rheinmetall has more than doubled revenues since 2022 to $14.7 billion while profits are up nearly four-fold.
Martin Gamble: Shares and Markets Writer
Martin Gamble is Shares and Markets writer at AJ Bell. He was previously the Education Editor of Shares Magazine. He has been with the business since 2019.
Martin graduated from the University of Kent in...
