BAE shares dive 5% on 'veiled profits warning'

BAE admitted falling profit margins at its customer support business would hurt earnings next year, sending shares in the defence giant almost 5 per cent lower yesterday. The news, which some commentators described as a "veiled profits warning", overshadowed an agreement with the Ministry of Defence on the Eurofighter programme and prompted analysts in the City to downgrade their earnings forecasts.

BAE had signalled for some time that margins in its customer solutions and support (CS&S) business would come down, but said yesterday the decline was happening earlier than expected, resulting in a lower contribution from the unit to group profits next year and underpinning only "modest performance improvement" for BAE in 2005. The company said the outlook for its 2004 profits was unchanged.

Margins at CS&S are falling as more work in the Al Yamamah support contract, such as repairs and overhauls, is being carried out in Saudi Arabia and as a result of a shift to less profitable support work for the MoD. The margins in the Al Yamamah programme are expected to stabilise from next year, BAE said.

The comments led Nick Wilson at Dresdner Kleinwort Wasserstein to cut his prediction for 2004 underlying pre-tax profits for the group to £845m from £870m, and for next year to £930m from £990m. He also cut his rating on the stock to "hold" from "buy", saying: "The updated CS&S comment is a little bit disappointing and heralds the first earnings downgrade for us." However, Mr Wilson said he expects an improvement in margins at the major programmes and avionics units combined with a strong commercial aerospace performance.

BAE also said it agreed with the MoD in principle on contract changes to the first batch of Eurofighters, as well as on Britain's share of further development and on its share of production of the second tranche of 236 aircraft.

"Negotiations are at an advanced stage and it is hoped that the tranche two order can be agreed by the governments of the four partner nations in the near future," BAE said. Britain, Germany, Italy and Spain have pledged to buy 620 Eurofighter jets over three tranches, but an agreement on the second batch had been delayed by negotiations over the specifications each buyer requires. BAE makes the aircraft in partnership with Eads and Finmeccanica.

BAE shares ended the day 11.75p lower at 245.5p.

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