Thursday, 23 January 2014

Chemring - good enough

I last posted about the UK-listed defence company Chemring in November (link here) where I concluded that

'Putting all the above together, I am particularly heartened by the progress on debt reduction.  Defence markets are not easy but this is not a slam dunk sell at all - the company retains some good market positions and opportunities, plus a near 4% yield for investors.  Additionally with an EV of around £700m it remains bite-sized enough for other entities to credibly take a look at it. 

An interesting share at prevailing'

I bought some shares then and even included the stock in my '14 global ex-US for 2014' list.  Pleasingly the share has bounced since then. 


So what progress can we discern from today's final results (for the year to the end of October)?

Well, the headlines are messy of course due to the issues the company talked about in October (and which induced my original interest in the shares).  Still underlying operating profit at just over £72m (-18% year-on-year) does capture my attention.  More on this later.

The outlook statement is solid and as expected.  I have emphasised the key points in my view:

Chemring will continue to drive improvements in operational performance, and pursue the growth opportunities that exist, particularly within non-NATO markets where defence spending is expected to increase. It will also reshape and strengthen its portfolio of businesses through the disposal of non-core activities and technology investment in those businesses that can achieve sustainable growth and margin improvement. Meanwhile, the Board's expectations for the current financial year remain unchanged
So much in turnarounds depends on the balance sheet as well as management vision.  Actual free cash flow generation of £28m in 2013 helped hold net debt levels to just under £250m, which itself at x2.5 ebitda is well within their banking covenants of x3.25 ebitda.  The dividend was cut by 25% to 7.2p (so the company now yields around 3%) as they wanted to keep dividend cover at around 3 times.  This combined with continuing disposals should help reduce debt further.  Sub £200m in a year's time?  That has to be a target...and will help valuation. 

Otherwise, it is noteworthy that the order book of £675m was slightly lower than the £702m stated in November due to 'exchange rate fluctuations'.  A small quibble but not a disaster.  More important is where it is going.  On this basis, divisional comments vary from 'robust' for sensors, to 'mixed' for munitions and to essentially opportunistic for countermeasures especially in the non-NATO world.  Is there enough or the company to be getting on with?  Absolutely. 

With an EV today of around £715m I observe that even using the just reported underlying operating profit number, the company is trading on around x10 EV/ebit.  Given I anticipate this number to increase and the net debt to decrease, a recovery back much closer to the 300p share price level of early 2013 seems reasonable.

My initial target is 285p or the level the share was at before the October plunge. 

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