> Energy, Materials & Industrials BAE Systems — Jaime Rowbotham, BUY, close 574p, 730p tgt, 27% upside ■ We see scope for 63% TSR to 2020. With FCF forecast at £1 .35bn in 2020, if the stock were to trade on a 5% yield then those buying now would make 18% TSR per year. Thus now is an attractive entry point into a multi-year defence spending up-cycle. ■ Flat earnings are masking a compelling growth story. We forecast EBIT growth at 5% at the company level. ■ US strength (9% EBIT CAGR to 2020) should come from growth in Combat Vehicles & Ship Repair and Electronic Systems, and a profit recovery at Applied Intelligence in Cyber. • It should be possible to offset declining Typhoon profit contribution in Air. The key drivers of this are Missiles (MBDA, in which BAE has a 37.5% stake, is growing at a 12% pa EBIT CAGR), Aftermarket and the stake in the F-35. There is upside potential to this from potential new Typhoon orders, such as from Saudi Arabia. • Maritime profitability is well-underpinned under this UK government, though there is risk from a change in government. • Cash conversion is set to improve from here on lower outflows on working capital, provisions (as most are now non-operational) and pensions (post the triennial review). • BAE trades on a discount to EU and US peers at c13.5x 19E PIE and c9x 19E EV/EBIT, versus 14.5x and 10.5x for EU peers, and 19x and 14x for US peers. • Catalysts: conversion of contract opportunities Related DB Research: BAE: Cashing in: >60% 3-year TSR potential (Rowbotham) Global Aerospace and Defence: Civil selective; Defence more effective (Kerner) Deutsche Bank £1.35bn FCF by 2020, driven by EBIT growth and better cash conversion 1600 1400 1200 1000 800 600 400 200 598 115 IIII1 127 840 282 90 110 Mil 93 (25) i4ci * de c% cc, ce se . 4k60 0* A 60 rfi ..tr e e p 9,<• get \ to 4% cp Source: Deutsche Bank eslinales 1350 BAE trades on a c30% discount relative to its