Investment Column: Outlook for BAE is too uncertain

Oil explorer Edinburgh has cash in the pipeline
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The Independent Online

Don't get too excited about the immediate financial prospects for BAE Systems, the giant defence contractor once known as British Aerospace.

Don't get too excited about the immediate financial prospects for BAE Systems, the giant defence contractor once known as British Aerospace.

This was the message yesterday of the company's own broker, ABN Amro, whose downbeat predictions for next month's interim results sent BAE shares down 3 per cent.

Those of us who put a veil over our conscience when choosing stocks to buy might decide that now is an obvious time to be buying a company whose products include fighter jets, naval frigates and torpedoes. But BAE (corporate slogan: "Innovating for a safer world") is struggling to recover from several years of internal problems, including cost overruns and some very public rows with the Ministry of Defence, one of its biggest customers.

While some in the market had been hoping the interims will show debt starting to come down, Sandy Morris, analyst at ABN Amro, warns that it might now be higher than the £870m at the start of the year. Although BAE is paid for one of its biggest contracts - with the Saudi government - in oil, the high oil price is not going to be reflected directly in cashflows. It will be a long-term beneficiary from the high price, but mainly through extra work from the Saudis in due course.

BAE's profits are improving, but only thanks to its 20 per cent stake in the civil aerospace business Airbus. On the military side, there are just too many things to fear. UK defence cuts mean less work in the long term, and there could be a scaling back of orders for the first-generation Eurofighter, too. Military spending could come under pressure in the United States as the presidential winner tackles the deficit. And the political situation in Saudi Arabia looks increasingly uncertain.

With BAE's long-term strategy uncertain and the shares even coming under friendly fire, as it did yesterday, it is difficult to muster enthusiasm for the stock. Avoid.

Oil explorer Edinburgh has cash in the pipeline

Edinburgh Oil & Gas is why many people play the stock market. This little oil exploration company hit the big time three years ago when the Buzzard oil field in the North Sea, in which it holds a 5 per cent stake, turned out to be the biggest oil find in the UK in more than a decade. The shares are up eightfold.

Yesterday's interim results showed lower turnover because it has sold some small onshore wells, but higher profits, because production from the wells that remain is being sold at the current sky-high oil price.

The main point of interest, though, was that work to build the Buzzard rigs is about 30 per cent complete, is on time and is on budget. Oil should start flowing by October 2006, and the company should quickly pay back the £55m debt it will have accrued in expenses.

We have twice tipped Edinburgh shares, at 104.5p in 2002 and 126.5p last year. Now they are 162.5p and still a buy for the bold punter. Analysts calculate the value of Edinburgh's assets at more than £2 per share, and that is using forecasts for the oil price that now look pretty conservative. The hope is that, as Buzzard moves steadily closer to production, the share price discount will narrow.

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