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Chemring^ (CHG, Buy at 298p) - In line full year trading update
Chemring Group PLC
FY trading in-line: Trading to 31 October is in-line with expectations (cons. adj. operating profit: £67.0m, INVe £66.7m). FY23 y/e net debt is expected to be £14.4m (previous: INVe £1m) largely due to £9m deployed into the £50m buyback and increase in working capital from the delay in the US DoD approving certain countermeasure deliveries, as previously flagged. Operating cash conversion remained a healthy 90% of EBITDA (3yr average: 101%). Energetics growth: Customer requirements are driving significant demand for niche energetics and in October, Chemring Nobel won >£40m of orders and Chemring Energetic Devices (US based subsidiary) secured a $46m order from United Launch Alliance for the Vulcan Centaur Rocket. Incremental capex: We update our net debt estimates for a further c£30m capex to expand capacity at Chemring Nobel in Norway announced today. This is due to significant increases in demand. Total investment in the three Energetics businesses over next three years is now expected to be c£120m, generating increased revenue of c£85m and operating profit of c£21m. We believe customer restocking in traditional capabilities has barely begun. US Sensors strategic review: The Explosive Hazard Detection business will be discontinued resulting in a £31m non-cash impairment of goodwill (acquired in 2009). Also, an impairment of £18m in relation to capitalised costs for AVCAD is recorded. The Group has moved quickly to reposition the US Sensors business and focus on the competitive advantage in biological detection (two sole source programs) will be positive for margins. Valuation: The shares trade on a CY24E EV/EBIT discount of 16% to international defence peers despite a higher margin profile. BUY reiterated.
UK Defence - Events in the Middle East escalate
CHG QQ/ BA/
Approvals secured: The trading update on 12th September noted that achieving FY expectations was subject to US Department of Defense approval of certain countermeasure deliveries, representing c.£25m of revenue, that had already been manufactured and would be recognised once approval had been received. The delay in approval concerned the quality of raw material provided by a third-party supplier outside of the Group’s control. The majority of necessary approvals have now been received and associated deliveries can now be made. Estimates in-line: The outturn for the year ending 31st October remains in line with expectations. Whilst the revenue and profit associated with these countermeasure deliveries can now be recognised, the delay in shipment may leave insufficient time for the cash to be received from the customer prior to 31 October and as such these cash receipts may fall into early FY24. Strong cover: Order intake to 31st August was £536m, up 47%, and the order book increased 44% to £829m. Expected FY23 revenue was fully covered and FY24 was 70% covered. In H1, Countermeasures & Energetics represented 54% of revenue and 44% of operating profit. Valuation, TP 430p: The £50m buyback has commenced and the shares trade on a discount to peers, despite stronger margins. Chemring is currently trading 17% below its 5-year EV/EBIT average and at a 23% discount to Hensoldt (N/R), despite a higher margin profile (see Fig 3 overleaf). Overall, a CY24E EV/EBITDA of 7.6x looks cheap for the improved quality, order book and balance sheet (ND/EBITDA of 0.3x at H1).
UK Defence - Middle East - geopolitical risks widen
Chemring Group PLC BAE Systems plc
DSEI 2023 - Photo Pack - Showcasing Innovation Across Defence
CHG QQ/ BA/ NXT
Chemring^ (CHG, Buy at 305p) - Trading update; timing issue not critical
Chemring’s update indicates that trading remains on track and our estimates are unchanged. There has been further healthy order intake since the interims, improving the order book to £829m from c. £750m at the end of H1. This sees order cover for FY24E at 81% at Countermeasures & Energetics and
Order intake on 31 August was +47% to £536m and the order book was +44% to £829m, driven by great progress across the group; notably Energetics and Roke. The outlook is robust, with improving medium term visibility and confidence and we reiterate our Buy recommendation and 410p target price.
Strong order cover: Trading to 31 Aug progressed as planned. The strong momentum in order intake, up 47% to £536m, enhances visibility with order cover out to FY25. The order book is up an impressive 44% to £829m. Expected FY23 revenue is now fully covered by the order book with c.6 weeks of the year remaining. Order cover for FY24E revenue (INVe) is 70%, with cover for Countermeasures & Energetics at 81% and Sensors & Information at 54%. Current trading: Achieving FY expectations is subject to US DoD approval of certain countermeasure deliveries, representing c.£25m of revenue (we estimate £8m-10m of adj EBIT) that have already been manufactured. This is simply timing risk. In S&I, Roke order intake was up 33% to £165m and mgt. expect a record year in FY23 with revenue >£160m. In C&E, the Chicago business order book is >£100m. Niche Energetics continues to see strong demand with intake up 122% to £211m; we see further strong prospects post our recent Ardeer site visit. Countermeasures received orders totalling £141m, +16.6% YoY. Significant wins: In Sensors & Information, Roke received an important £40m award to deliver the next 2yrs of Project ZODIAC (ISTAR) for the UK MOD as the Prime Systems Integrator. Deliveries are expected to commence in late FY23 with completion in early FY25. In US Sensors, it is encouraging to see the procurement decision of the JBTDS program was approved, with an LRIP contract valued at $15m. In Countermeasures & Energetics, the Chicago business (niche energetics) received two contracts totalling $23m to supply Lockheed. Countermeasures received $17m for the delivery of MJU-75 flares in Tennessee, and £24m for a range of products in support of the UK MOD. Valuation: A CY24E EV/EBITDA of <9x is attractive for the improved quality and order book. The shares are trading 8% below the 5-year EV/EBIT average and at a 20% discount to Hensoldt (N/R), despite a higher margin profile.
Chemring^ (CHG, Buy at 305p) - Model update -
Chemring (CHG, Buy at 284p) - Share buyback scheme announced
Strong discipline: Management retain a disciplined approach to capital allocation, prioritising organic & inorganic investment, a growing & sustainable dividend and a prudent approach to leverage. The b/s is in good shape, with net debt/EBITDA of 0.3x at 30 April and a robust pipeline of opportunities. The buyback should deliver value for shareholders, whilst still maintaining a strong b/s. The programme will end on 31 July 2024, investment opportunities will continue to be assessed for its duration, and it will not impact the dividend policy. M&A strategy: The acquisition of Geollect last December, for an initial consideration of £7m, again showed management can secure selective bolt-ons for Roke. Management continue to explore opportunities to expand and accelerate the Sensors & Information capabilities but any acquisition must meet a strict set of criteria, enhance shareholder value & fit with wider growth plans. Capex plan: We visited the niche energetics site in Scotland last month, a critical supplier of explosives, propellant and energetic devices. It represented c.10% of FY22 sales, achieves high margins and attracted 50% of the £90m expansion capex announced at H1, spread over 3 years. This, often overlooked, asset is replacing old plant and growing capacity to deliver c.£30m of incremental revenue. A further £30m in aggregate is expected from the other niche energetics sites in Norway and USA. Customer stores of traditional capability are low, suggesting sustained demand over the next decade. Our view: The creation of a deployable balance sheet is the result of impressive business improvement over recent years. Moreover, this buyback reflects confidence in the outlook and commitment to balance near-term performance with longer-term value creation. The shares on a forward EV/EBITDA of <9x represent an attractive opportunity given improved visibility, sector-leading margins and a strong balance sheet. Next catalyst: DSEI show in September.
Interim results better than our conservative expectations, which provides a healthier H1/H2 profit split to unchanged full year guidance (our FY23E EBITA 61% H2 weighted), which is also c. 90% covered by the order book. Further very strong order intake (+82% cc. YoY) in the period, sees the order b
H1 results: Interims are in-line with the Board’s expectations but ahead of ours and show the order book up 54%. H1 profit implies a 60% H2 bias vs. our 65% expectation. As flagged since H1 last year, the extended US Continuing Resolution caused H1 revenue to decrease by 4% and op. margin by 270bps to 12.5%, resulting in Adj. EPS decreasing by 29%. The interim dividend, however, is increased by 21% to 2.3p. Net debt increased to £25m (H122: £18.5m) due to WC investment; the b/s remains strong at 0.3x ND/EBITDA. FY outlook: Expectations are unchanged. H2 order cover has improved to 90% (H122 85%), split 99% in C&E (H122: 98%) and 72% in S&I (H122: 59%). This leaves £518m of the order book to be delivered next year and beyond. Countermeasures & Energetics: H1 profitability reflects the gearing impact of being H2 weighted and increased energy costs. However, given improving demand and visibility in Energetics, a £90m capacity expansion plan to 2026 has been initiated. This is expected to deliver incremental annual revenue of £60m and operating profit of £13m (22% margin) in 2026/7. Sensors & Information: Profitability declined due to the HMDS program transitioning to sustainment and ongoing investment at Roke. Roke’s revenue was up 44% to £78m and order intake up 41% to £82m with the business well positioned for further growth. Management has raised ambitions to increase Roke’s annual revenues to >£250m organically by 2028 (vs. £200m by ’27). Estimate changes: Our Adj. EBIT estimates change only in mix. We upgrade Adj. EPS in FY23E by 3.6% to 18.8p reflecting a lower tax assumption. We update capex estimates to reflect the new Energetics capacity expansion. Valuation: The shares trade at a 17% discount to the sector and 13% below the 5-year average on our CY23E EV/EBIT; an opportunity given improved visibility, sector-leading margins and deployable b/s. Buy re-iterated, TP 430p.
5 - 9 June 2023
CHG GHH PAG PAGE DSCV CRST CRH GLV MRO MELR MTO RWS RSW
Appointment of James Mortensen as Chief Financial Officer James has an established track record in industrial, engineering and technology sectors. With seven years at Smiths Group, he brings valuable M&A expertise; he joined the Smiths M&A team in 2016 and became the CFO of Smiths Medical Division in 2020 ($1.1bn of revenue), until the sale for $2.7bn in 2022. Currently, James is Group Head of Corporate Development, responsible for sourcing, evaluating, and executing acquisitions across global markets in Security & Defence, Aerospace, General Industry and Energy. Our view This appointment is a strong fit with James’s track record and demonstrates M&A intent with the deployable balance sheet (net cash in 2023E). FY23E/24E/25E Net Debt/EBITDA of -0.05x/-0.3x/-0.5x. The shares trade on a CY23E P/E of 14.6x, EV/EBITDA of 8.2x, FCF yield of 5.9% and DPS yield of 2.7%. Next catalyst: H1 results 6th June.
Whilst customer procurement delays, labour availability issues and other inflationary pressures still need to be managed, the group is responding accordingly and remains well positioned for growth in both of its key sectors. Trading on a PE <14x Oct24E we reiterate our Buy rating.
Chemring's AGM update indicates that both trading and outlook remain in line with expectations and guidance unchanged, underpinned by further growth in the order book to £677m (+42% YoY, or we estimate c.+30% cc. and compares with £651m at end of FY22). Order cover has increased to 90% (vs. 89% at
Quality defence: Having started the year with order cover of 86%, expected FY revenue is now 90% covered (vs. 89% last year) by revenue to date and the current order book, split 99% in Countermeasures & Energetics (vs. 99% in Feb ‘22) and 76% in Sensors & Information (vs. 73% in Feb ‘22). The order book stood at £677m in Feb, up 42% Y-o-Y. The security environment is driving demand in active cyber-defence, operational support and open-source intelligence, and space-launch systems. Demand also continues to grow for propellant and energetic materials, and high-integrity missile sub-components. Both sectors have performed as expected YTD; the group is mitigating the impact of inflation, proving its quality and importance to customers. Countermeasures & Energetics: Propellant and energetic material demand is rising as customers re-evaluate usage and stockpiles. The Scottish and Norwegian businesses have record order books. We highlight Chemring is the only qualified supplier of rocket and flight motors for the NLAW, which should benefit FY25/6 given recent orders placed with the OEM Saab. Sensors & Information: Order intake was strong across all areas including in Futures (£24m in the last 12m) via accounts with Rolls Royce, Waygate and Vodafone. It is also developing accounts in digital healthcare. US sensors received a third option worth $15m under the sole-source $99m IDIQ contract for the EMBD program. Updates on other programs are expected in Q2. Valuation: A forward EV/EBITDA of 8.5x, below the five-year average, looks a buying opportunity given demand, sector-leading margins, deployable b/s (net cash by y/e) and scarcity value in a shrunken listed defence sector. We have a 430p TP. BUY. Next event: Interims on 6 June. We expect 65% H2 EBIT bias (10yr av. 60%).
Andrew Lewis is declaring his innings closed, after six years as CFO. Having informed the Board of his intention to retire, his notice period is 12 months. He will continue in role to ensure a smooth transition. The Board has commenced a search process to identify his successor. He will be leaving Chemring strongly repositioned and in good shape to take advantage of growth opportunities. As a reminder, FY22A results represented a fourth consecutive year of constant currency growth, with no restructuring costs, cash conversion >100% and improved net debt/ebitda of 0.1x. The shares trade on a CY23E P/E of 15.4x, EV/EBITDA of 8.7x, FCF yield of 5.6% and DPS yield of 2.5%.
Given the moving parts in the demand profile and production challenges, we view this as an impressive performance. The global political landscape and areas of focus for defence and security spending underpin our confidence in the story and we reiterate our Buy recommendation and 410p target price.
Results in line with upgraded expectations, despite the drop in HMDS sales in H2. Year-end order book £650.9m (+21% YoY cc. vs £678m at end of Sept), provides 86% cover (vs. 84% at same point last year) for unchanged FY23E guidance. As we have previously discussed, FY23E is expected to have a great
A confident update from Chemring, indicating that all is on track for FY22E and backed by impressive order growth, providing better visibility for next year than is typical at this stage of the year. We retain our BUY rating, with the shares providing high earnings confidence in the current uncerta
Strong order intake: as of 30 September 2022, the order book was £678m (30 April 2022: £488m), with an FX tailwind of £40m arising from the strong US$, up £150m or a 31% increase on a constant currency basis since the interims. Order cover for FY23 is building strongly, with Countermeasures & Energetics having 93% expected revenue cover while the shorter-cycle Sensors & Information sector is at a healthy 60% (divisional details on page 2). Forecasts underpinned, plus upside potential from FX & tax: We leave our forecasts unchanged; however, current FX rates, particularly US$, provide positive tailwinds to our forecast horizon. This is more pronounced in the medium-term given that the order book for Countermeasures & Energetics spans out c.18 months and hedges are positioned at c.$1.30. There is also a potential UK tax tailwind with rates not increasing to 25%; this could positively impact the Group’s ETR by 1% in FY23 and by 2% in FY24 and beyond – we note that one third of Group profits are generated in the UK. Balance sheet flexibility: Net debt/EBITDA was <0.5x through the year and no material impact is expected from increasing rates. Management has built a strong balance sheet, a premium in a leverage-adverse market, providing optionality for selective M&A (with a c.£160m facility secured to Dec 2024). Our view: This is a positive update. The order book growth provides strong visibility and further evidence that management are executing in a difficult operational environment. Longer-term potential remains, particularly with current geo-political tension. A strong balance sheet and scarcity value (a mid-teens margin, quality defensive, with strong cash conversion), combined with the shift in the NATO defence outlook allows confidence in the equity story. Our 430p TP implies >40% upside.
Reminder of details: In January 2018, an investigation was opened by the SFO into the Group and subsidiary, Chemring Technology Solutions Limited, following a self-report made by CTSL. The subsidiary specialises in Explosive Ordnance Disposal products. No reason for the investigation closure is given in the statement today. We believe Chemring has significantly improved compliance since 2018, under new management. Immaterial residual risk: The SFO investigation closure now retires the third of four contingent liabilities reported four years ago. The Group continues to support the HSE as it undertakes its investigation into the incident at the countermeasures facility in Salisbury in August 2018. Whilst provisions have been recorded for costs identified (included within legal provisions), possible additional uninsured costs and penalties are not anticipated to be material. Scarcity value: The improvement of Chemring is being increasingly noticed, in our view, not least in the USA from where we have just returned. There are now few ways for investors to gain quality defence exposure in the UK, given Ultra Electronics is due to be owned by Advent/Cobham by late Summer. Chemring’s mid teen margin, high cash conversion, low net debt and liquidity are increasingly attractive compared to the remaining UK sector and EU defence stocks. The shares currently trade on a 10% discount to Hensoldt, Rheinmetall and Thales on a forward P/E basis despite Chemring generating 320bps higher operating margin to their average of 11.3%. H1 review: Interims, announced earlier this month, showed revenue up 11% and Adj. EPS up 27%. With H2 order cover of 85%, FY expectations were unchanged despite a c.10% profit headwind from utility inflation and order timing effects of the US CR, combined with discretionary opex in Roke.
H1 results ahead of expectations but full year guidance conservatively unchanged, reflecting ongoing US procurement delays (principally the annual HMDS call-off from the DOD - under the existing PoR - which typically is placed in Q2, but has yet to be received) and further investment to support Rok
Strong 1H, in line with expectations Chemring has delivered a strong first half, with a solid performance in both the Sensors & Information and Countermeasures & Energetics segments. Margins continue to progress, and the outlook (both near term and longer term) remains confident. We leave our numbers unchanged and reiterate our Buy recommendation and 450p target price, as laid out in our note published 29 April (Revised SOTP for a changed world). Henry.Carver@peelhunt.com, Harry.Philips@peelhunt.com
H1 results: Interims were in line, following the upgrade with the AGM update. Revenue increased by 11% (8% at constant currency) and operating margins improved 100bps to 15.2%, resulting in Adj. EPS increasing by 27% vs H121 (22% at constant currency). The interim dividend was increased by 19% to 1.9p. Divisionally, Sensors & Information momentum continues with Roke again delivering double-digit growth in orders, revenue, and profit. Roke remains well placed. Countermeasures & Energetics continues to improve profitability as a result of operational improvements across the segment. Deployable balance sheet: Net debt of £18.5m was 52% better vs H121, and represents just 0.2x ND/EBITDA. Strong operating cash conversion continued at 101%, with 3-year rolling operating conversion of 106%. Management have built a strong track record of improving Chemring and appear ready for more. FY outlook: H2 order cover is 85% (H121 92%). Utility inflation, discretionary investment in Roke in H2, and adverse US order timing are expected to offset current FX tailwinds and the expected improved H1 weighting this year. Estimate changes: Our profit estimates are unchanged after mix tweaks. This implies an H2 operating profit bias of 48% vs. 52% last year. We increase post IFRS 16 Net debt by £5m to £20m to reflect a new operating lease in Woking. Our view: While the upgrade cycle pauses, winning the war against current cost inflation is commendable. Longer-term potential has increased due to current geopolitical uncertainty. Outer year estimates have headroom to rise. Our SOTP-based 12m TP remains 430p and our Bull Case valuation of 522p is intact. Multi-year visibility, a strong balance sheet, and scarcity value (a mid-teens margin defensive with strong cash conversion), combined with the shift in the NATO defence outlook allows confidence in long-term prospects. Buy. TP 430p.
Revised SOTP for a changed world, TP raised to 450p Given the significant changes we are seeing in the geopolitical landscape, we have revised our SOTP analysis that we originally carried out back in January 2021. Whilst we are leaving our forecasts unchanged (the next scheduled news flow from the company is the interims on 8 June), we upgrade our TP by 25% from 360p to 450p to reflect our higher confidence, underpinned by stronger underlying market trends in cybersecurity, electronic warfare, and sensing and electronics, plus the imminent completion of a major capex investment programme. We reiterate our Buy recommendation. Henry.Carver@peelhunt.com, Harry.Philips@peelhunt.com 11-page note
Meeting Notes - Mar 31 2022
CHG BAG DFS GAMA ERM HSW VANQ TRN RIV RNWH
In light of recent sector developments, share price rise and further recent strong updates we revisit the investment case for Chemring. Russia’s invasion of Ukraine has seen a sea-change in opinion towards defence spending in the West, It has also seen a reset in terms of how the sector is viewed f
AGM update; trading slightly ahead Chemring has issued a trading update ahead of the AGM later today confirming that both sectors performed well during 1Q and that, thanks to recent positive order intake, the board now expects FY22E to come in slightly ahead of expectations. This is an encouraging update at this stage of the year, and the geopolitical backdrop has highlighted the importance of investment in defence, which will likely underpin the medium-to-long term outlook. We reiterate our Buy recommendation and 360p target price. Henry.Carver@peelhunt.com, Harry.Philips@peelhunt.com, Afonso.Osorio@peelhunt.com
Chemring's update demonstrates further good momentum, despite the Continuing Resolution in the US, with trading slightly ahead, and we nudge our estimates higher accordingly. Chemring trades on a revised Oct FY23E PER of 16.6x and remains well-placed as levels of and sentiment towards defence spend
Recent share price weakness means that Chemring is trading on an Oct FY23E PER of 13.5x, which we feel is too cheap given the progress made and opportunities ahead. Post the current period of capital investment, we estimate FCF could exceed £50m (equating to a yield of c. 7% at the current share pr
Recent progress: Despite sector-wide headwinds last year, including procurement and supply chain issues in the US and ongoing CV-19 disruption, Chemring’s FY21 results printed on 14 December 2021 delivered a third consecutive year of i) order book growth with improving order cover, ii) organic revenue growth, iii) margin progress on a more stable business mix, iv) no exceptional P&L items, v) operating cash conversion above 100%, and vi) reduced period-end net debt and intra-period net debt volatility. The strong results and outlook caused us to upgrade FY22/23E EPS by 4-5% at the time. Catalysts present upside: In the next 6-9 months, we expect further progress on US Sensors programmes of record with Low-Rate Initial Production (LRIP) decisions expected on both the JBTDS and AVCAD programmes, presenting upside risk to our forecasts if awarded. We re-publish our Group earnings upside scenario in this note, which generates a Bull Case valuation of 515p. Deployable balance sheet: With FY21A net/debt EBITDA of 0.35x and net cash, on our estimates, achieved by FY23E (Oct y/e), there appears sufficient balance sheet flexibility to execute on potential inorganic opportunities. We note the acquisition of Cubica (announced June 2021) as potentially being indicative of the size and strategic direction of possible future acquisitions. Attractive free cash flow: Following a period of modernisation investment, Chemring’s free cash conversion (FCF/adj. PAT) is inflecting upwards this year (>80% by FY23E). A FCF yield of 4.5% in CY22E rising to >6% in CY23E appears attractive, with Defence generally uncorrelated to moves in bond yields relative to other industrials, providing defensiveness in a market rotation as well as the upside to sentiment from a changing geopolitical landscape. Next scheduled event: AGM statement – 03 March 2022. No changes to estimates: TP 410p (unchanged). Reiterate key Buy.
Chemring Group PLC Unilever PLC
Introducing FY24 estimates Post the results in December we have updated our model and are locking in the c.4% EPS upgrades to FY22E and FY23E that we flagged at the time. We are also publishing our FY24E forecasts that reflect continuing positive trends in Sensors & Information, driven by Roke, and also firm demand in Countermeasures & Energetics underpinned by the F-35 programme. We reiterate our 360p target price and Buy recommendation. Henry.Carver@peelhunt.com, Harry.Philips@peelhunt.com, Afonso.Osorio@peelhunt.com
Results in line in a challenging year; Roke momentum As suggested by the post-close update last month, Chemring has delivered results in line with expectations, with good progress on all fronts and momentum in its end markets. Roke continues to grow at double-digit rates, with orders breaking £100m for the first time, and the rest of the business is performing well. This is an impressive set of results given last year was far from straightforward, which delivers on a forecast struck almost three years ago. We reiterate our Buy recommendation and 360p TP. Henry.Carver@peelhunt.com, Harry.Philips@peelhunt.com, Afonso.Osorio@peelhunt.com
Chemring has delivered its third consecutive year of organic growth, with further good cash conversion (EBITDA 105%) and strong order growth as the strength and quality of earnings improves and track record builds. Order cover of c. 84% of expected revenue (implied c. £426m given £358m of £501m ord
Bucking the trend: FY21A results in-line, following a cash upgrade last month, driven by strong Sensors & Information performance despite sector-wide headwinds, incl. US procurement and supply chain challenges, ongoing CV-19 disruption and adverse FX. Revenue, adj. operating profit and adj. EPS increased by 1%, 10% and 17% respectively at CC. Roke stands out as a highlight, with another year of double-digit growth in orders, revenue and operating profit, with record order intake >£100m. Progress on US Programs of Record continues and the Tennessee Countermeasures facility capacity expansion is on track for initial revenues in the 2H of 2022. The balance sheet appears deployable, with year-end ND/EBITDA of <0.4x, going to net cash in FY23E on our new estimates. There is a promising pipeline of opportunities. Track record continues: Despite headwinds, the Group has now delivered three consecutive years of i) order book growth with improving order cover, ii) organic constant currency revenue growth, iii) margin progression (on a more stable business mix), iv) no exceptional P&L items, v) operating cash conversion above 100%, and vi) reduced net debt and intra-period volatility. Estimate changes: We increase revenue assumptions modestly, with adj. operating profit expectations unchanged as upgrades to Roke growth and margin are offset by greater caution in the Countermeasures & Energetics margin and higher central costs. Driven by lower interest and tax, we upgrade FY22E/23E adj. (FD) EPS by 4%/5%. Building on the Bull Case: Having reflected higher Roke growth and margins in our forecasts, we roll-forward and expand our Bull Case earnings scenario, which sees an increased upside valuation of 530p/share, discounted back. Valuation: Now trading on a FY22E P/E of 16.0x and EV/EBITDA of 9.8x. We would also highlight the improving FCF yield as capital intensity reduces. Our SoTP-derived 12m TP increases to 410p (from 405p). Retain Buy.
Click here to see the note Key Stocks Chemring (Buy, TP 360p): Anticipate increasing demand for cyber security (Tuesday 14 December, Prelims) Joules# (Buy, TP 350p): Peaking for peak? (Tuesday 14 December, 1H trading update) Baltic Classifieds Group (Buy, TP 250p): First results since IPO (Wednesday 15 December, Interims) Hollywood Bowl (Add, TP 275p): Buying opportunity (Wednesday 15 December, Finals) IntegraFin# (Buy, TP 650p): Consistently delivering (Thursday 16 December, Finals) Stocks Previewed Baltic Classifieds Group, Chemring, Hollywood Bowl, Hyve Group, IntegraFin#, Joules#, Purplebricks# Macro highlights A very busy week ahead featuring updates from all the major central banks. The likelihood of a pre-Christmas rate hike in the UK has surely declined given the renewed Covid-19 restrictions; October’s GDP reading also disappointed and risks to 4Q growth are now tilted to the downside. Even the MPC’s chief hawk Michael Saunders has suggested there is a case for waiting until the New Year. The ECB appears to be leaving all options open, with reports suggesting a push from some council members to introduce additional flexibility into its Asset Purchase Programme. In the US, the labour market data have confirmed conditions continue to tighten, so the Fed will likely reiterate its accelerated tapering timetable. The data calendar is also packed, including all the major UK monthly updates: labour market, inflation, retail sales and the flash PMIs. 6-page note #Corporate client of Peel Hunt
CHG BOWL IHP HYVE BCG PURP JOUL
FY trading performance in line: Trading performance in the year to 31 October is in line with market expectations (consensus adj. operating profit: £57.5m, INVe £57.2m). FY21E year end net debt is now expected to be £27m, representing an 18% improvement to our previous estimate. Company-defined operating cash conversion is 105% of EBITDA, with rolling 36 month operating cash conversion of 107%, testament to the improved quality. FY22 order cover building: In October Chemring was awarded the Full Rate Production contract for the Enhanced Maritime Biological Detection (EMBD) US Program of Record. The sole source framework contract is valued at up to $99m, with an initial order of $16m for delivery in Q4 FY22 and FY23. Chemring Australia also received a contract modification for F-35 countermeasures in the amount of $20m, in addition to the $22m contract announced on 28 September. Following these awards, the closing order book was £502m (vs £476m in the prior period) giving 83% cover of FY22E revenue (vs 78%), with Countermeasures and Energetics at 94% (vs 92%) and Sensors & Information at 65% (vs 53%), with strong demand seen at Roke. Estimate changes: With FY21E (Oct y/e) expectations met, we leave FY22E trading assumptions unchanged for now, as we continue to be mindful of the challenging operating environment in the US, albeit given continued strong order momentum this may prove conservative. Our FY21E net debt estimate improves 18% to £27m, with ongoing working capital management aided by lower capex and cash tax in FY21E, offset slightly by higher incentive shares. Our view: Chemring has navigated a challenging US environment that has caused issues elsewhere in the sector. The improved quality of the group can also be seen in the continued high operating cash conversion. Our SOTP-derived 12m TP nudges up to 405p (from 400p) on lower net debt. The balance sheet appears deployable. Prelims on 14 December. Re-iterate BUY.
CHG ENT FDP FLTR HSX IWG FSJ MKS STAN WOSG
Contract wins and reassuring post-close update Chemring has issued a reassuring post-close update this morning confirming two contract wins in the last quarter, and trading in line with expectations. This seems out of kilter with the recent share price weakness and we would therefore see this as a buying opportunity ahead of the results on 14 December. The shares are trading on PE ratios of 16.5x FY22E and 15.9x FY23E. Henry.Carver@peelhunt.com, Harry.Philips@peelhunt.com, Afonso.Osorio@peelhunt.com
Solid 3Q update; PH upgrade to middle of the range Chemring’s 3Q update confirms a solid performance, reflecting continuing strong demand for Roke, robust delivery of countermeasures & energetics and good progress in sensors. We are upgrading PHe FY21 EPS by 2% and increasing our TP to 360p from 350p. Our revised TP equates to a PE of 21x FY21E falling to 20.5x FY22E, which is undemanding, in our view (supported by recent deal activity in the sector). We see more upside to come, especially from Roke and Cubica, and reiterate our Buy recommendation. Henry.Carver@peelhunt.com, Harry.Philips@peelhunt.com, Jolyon.Wellington@peelhunt.com, Afonso.Osorio@peelhunt.com
Chemring's robust update is in line with expectations and full year guidance is unchanged. We make no changes to our estimates as a result, other than to reflect the lower than expected net debt position (principally due to lower capex and cash tax), but believe these are well underpinned. Chemring
Q3 update: Trading is in line despite a challenging US backdrop. Strong operating cash conversion continues, with net debt at 31 August of £38m (30 April: £39m). Expected FY21E revenues are fully covered by the order book, which has grown 3% since 30 April to £464m. FY21E trading expectations are unchanged (consensus adj. operating profit: £57.5m; INVe: £57.2m). Sensors & Information: The sector has seen continued strong performance, with order intake 7% higher than the prior period. Roke continues to trade well, with a strong outlook. Establishing Roke USA should support further growth, with several Electronic Warfare systems currently on trial with the US Army. The integration of Cubica is progressing well. Progress in US Sensors continues, with a Full Rate Production contract on the Enhanced Maritime Biological Detection programme expected later this year. The AVCAD and JBTDS bio agent detection programmes continue through their EMD phases. Given shorter cycle orders, FY22E cover stands at 45% (vs 47% prior period). Countermeasures & Energetics: Performance has been in line with expectations, with CV-19 and Administration change-related disruptions (including timing of customer acceptance tests and labour and supply-chain challenges) not having had a material impact to date. FY22E order cover of 67% compares to 82% last year, which benefited from the 2-year Countermeasures Australia order received in FY20 that has been traded down. A follow-on order is expected this year. Tennessee expansion is progressing as planned. Cash upgrade: FY21E net debt improves 27% to £33m, driven by lower cash tax and capex timing. FY22E improves 21%. No changes to trading forecasts. Our view: FY21E revenue fully covered by orders, a cash upgrade and an encouraging pipeline of opportunities, all despite the current challenging US backdrop, highlights the transformation at Chemring over recent years, in our view. SoTP-derived 12m TP of 400p. Re-iterate Buy.
Interim results better than expected, further demonstrating the progress that has been made at Chemring in recent years. EBITA grew +10% YoY (+16% OCC) delivering an H1 margin of 14.2%, c.550bps better than that generated in H1 19, and backed by cash, with underlying cash conversion of 96% after 11
Solid interims, in line against FX headwinds, and a small AI acquisition The company has delivered a solid set of interims this morning which are running slightly ahead of where we were, giving us absolute confidence in the FY. In a separate statement it has also announced a strategic bolt-on acquisition in machine learning and artificial intelligence that will help accelerate Roke’s already impressive growth. The outlook is robust, and the business is clearly on the front foot. We reiterate our Buy recommendation and 350p target price. Henry.Carver@peelhunt.com, Harry.Philips@peelhunt.com, Jolyon.Wellington@peelhunt.com, Afonso.Osorio@peelhunt.com
1H21 results: 1H21 audited interims were in line, following the FX headwind flagged at the AGM update. Revenue increased 4% (8% at constant currency) and operating margins improved 80bps to 14.2%, resulting in Adj EPS increasing 20% vs 1H20 (27% at constant currency). The interim dividend was increased 23% to 1.6p. Divisionally, Sensors & Information momentum continues with Roke again delivering double-digit growth in orders, revenue and profit. US Sensors programmes are progressing as planned. Countermeasures & Energetics continues to improve profitability. Continued strong cash generation: Operating cash conversion remains >95%, with 2 year rolling operating conversion of 105%. Net debt of £38.7m was 36% better than 1H20, and represents 0.5x ND/EBITDA. Small acquisition: Announced separately, Roke has acquired Cubica, a specialist in machine learning, data and autonomy, for initial cash consideration of c£7m. Last year Cubica reported adjusted PBT of £0.8m on revenue of £2.9m. Estimate changes: Organic trading assumptions are unchanged after mix tweaks. FY21/22/23E adj EPS increases 11%/7%/4% mostly due to lower tax. FY21/22/23E net debt reflects continued underlying cash generation and reducing capital intensity offset by the acquisition cost & small investment. Outlook: H2 order cover is 92% (1H20 95%). A new dividend policy, moving towards 2.5x cover (FY20A 3.8x) over the medium term, signals confidence in the outlook while balance sheet strength provides further optionality. Our view: More than two years into a successful turnaround, progress continues to be delivered and with a steadier rhythm. Our 12m TP increases to 400p (from 375p) - our Bull Case scenario from December 2019. Our current Bull Case scenario for 500p remains intact. BUY reiterated.
AGM update: trading in line, FX translation headwinds FY21 has started well with the book-to-bill ratio running at 127%, cash generation strong, and the positive outlook underpinned by long-term contracts. We make no change to our underlying assumptions, but are pushing through a 4% adjustment to PBT to reflect the strength of Sterling against USD. Our recommendation remains Buy. Henry.Carver@peelhunt.com, Harry.Philips@peelhunt.com, Jolyon.Wellington@peelhunt.com, Afonso.Osorio@peelhunt.com
Chemring's update confirms that underlying trading in the first four months of the year has been in line and, bar the potential impact of FX translation, full year expectations are unchanged. We initiated coverage last week, assuming an average exchange rate of $1.38/£ for Oct FY21E and with guidan
Chemring has made significant progress in recent years. The improving quality and visibility of earnings has been rewarded with a higher rating, but we believe there is more to go as the track-record builds.
Plenty of flare We have seen Chemring transformed over the last three years under this management team. We believe the business is now in excellent shape and well set to build momentum from here. Non-core operations have been exited, cash-flow metrics have improved drastically, the balance sheet is in good shape and the outlook is positive and underpinned by long-term visible contracts, eg for F-35 countermeasures. We believe the shares will continue to re-rate and increase our TP to 350p (from 280p) and raise our recommendation to Buy (from Add). Henry.Carver@peelhunt.com, Harry.Philips@peelhunt.com, Jolyon.Wellington@peelhunt.com, Afonso.Osorio@peelhunt.com 13-page note
FY profit and cash upgrades: FY revenue is now fully covered by orders, and Q3 trading in line with management expectations leads to FY profit expectations now being at the upper end of consensus. FY net debt is expected to be materially better at c.£60m, i.e. flat vs 1H20 despite increased investment, driven by continued strong operating cash conversion. Cover building: FY21E order cover (on increased revenue) is now c.60%, with Countermeasures & Energetics (C&E) at 82%, and the shorter-cycle Sensors & Information (S&I) at 47%, where order intake was up 32% vs the prior period. Divisional summary: In S&I, delivery milestones were met against the HMDS Sensors programmes, EMBD progressed to low-rate initial production ahead of plan, and JBTDS and AVCAD testing continue. Roke delivered the first “Resolve-Light” EW systems in the period and security markets remain buoyant. In C&E, the Australian business has made excellent progress, delivering against the US DoD F-35 contract. The UK business is meeting volume objectives and is now focused on operational improvement. The US businesses have seen some CV-19 related challenges, but these have not had a material impact on deliveries. Tennessee capacity expansion is progressing as planned. There is strong demand from space customers in Energetics. Changes to estimates: FY20E revenue increases by 5%; FY21E/22E increase by 3%/2% respectively. FY20E adj. operating profit increases by 3%. We hold FY21E/22E profit forecasts, with increased growth (e.g. in U.S. Sensors) having a modest mix effect. FY20E net debt improves 21% to £60m. Path to 400p: In our view, progress being delivered across the Group should increase the level of confidence in our Bull case, which we summarise in this note. Chemring continues to benefit from market-leading positions across 80% of its revenues, and remains a key Buy. We raise our TP to 300p (from 265p).
CHG CHRT FDEV GOOD OSB OSB SMS TBCG TM17
1H20 results: Trading in the first half was ahead of expectations driven by strength in both segments as well as phasing benefits. US Sensors procurement is progressing: The HMDS IDIQ was increased by $200m post period end, EMBD received an LRIP award and AVCAD is on track. Roke delivered double-digit revenue and profit growth. Countermeasures continues to see strong demand, with improved performance at UK and Australian sites. Financial performance: Operating cash flow increased 157% and represents 160% of EBITDA, highlighting the improved cash collection culture. Liquidity has been increased, with £50m drawn on a new £100m short-term facility. Cash at 30 April was £104.2m providing £187.8m of immediately available liquidity. Improved order book quality: FY order cover was 95% at 30 April. Visibility and quality is improved at both segments. Commoditised energetics is exited. Appointment of NED: Also announced today, Fiona MacAulay joins the Board as a NED with immediate effect. Fiona brings a wealth of global industrial experience and is currently a NED and RemCo. Chair at Ferrexpo. Changes to estimates: We increase FY20E revenue by 7% while leaving adj EBITA unchanged as CV-19 restrictions lead to some inefficiency. FY20E adj EPS increase by 5% on lower FY tax. FY21/22E adj EPS are unchanged. FY20E net debt is lowered by c.7m to £76m, driven by strong underlying cash generation and a greater cash contribution from the disposal of COR. This represents a c.£10m underlying improvement vs FY19, i.e. excluding leases and FX. Our View: These results highlight the improvement in quality across the Group. Despite some fears of defence budget pressure, we see the Bull case (see here) as intact. Chemring benefits from its market leading position across >80% of its revenue. Our TP increases to 265p (from 260p). BUY re-iterated. BUY.
Completion marks exit of commoditised Energetics On 21 November 2019 Chemring announced it had entered into a conditional agreement to sell its US subsidiary Chemring Ordnance, Inc. (COR) to Nammo Defense Systems Inc. for a cash consideration of $17m, subject to regulatory approvals and a working capital adjustment on completion. All regulatory approvals have now been received and the sale has completed. $15m net proceeds Net proceeds are expected to be $15m, with the final working capital adjustment to be finalised in the next 60 days. Our FY20E net debt of £83.0m reflects our conservative assumption that net proceeds would come in at c.$12m (£9m). Our view Completion marks another step on Chemring’s journey to being a higher quality company. All commoditised Energetics business have now been either exited or disposed. Operational improvements have been made and contract wins have built visibility, with wins on long-term Programmes of Record and strong demand for Countermeasures, delivered from the Group’s UK, US and Australia manufacturing sites. No update on current trading is given, having updated the market on 14 April. At that time, some customer testing, inspection and logistical disruption had been managed and orders continued to flow. FY20 order cover is >90%. 1H20 results are due on 03 June
Ofwat consulted on proposals to address liquidity challenges and increases in bad debt in the business retail market on 16th April, and last night published a number of proposals in light of responses to the consultation. The decision is set to be published on Thursday 30th April. Liquidity – Ofwat is recommending that retailers should receive liquidity support to the end of July. This period could be extended by further review and consultation. Support will be provided by requiring retailers to pay wholesalers a minimum of 60% of wholesale bills, or a proportion equivalent to the proportion of invoiced amounts recovered from customers, whichever is the higher. The percentage is lower than the 70% set out as a minded-to position in the consultation. These will be deferred payment arrangements, and the expectation is that deferred wholesale charges should be paid back by end March 2021. This is later than the ‘end of 2020’ set out in the consultation. Interest can be charged by wholesalers, but capped at 5.98% nominal. Retailer bad debt exposure – bad debt levels in the business retail market normally sit at around 1% of annual turnover, and Ofwat has proposed that retailers should absorb, in full, incremental bad debt costs equal to 1% of their annual turnover. If it looks like bad debt across the market will exceed a 2% threshold, Ofwat will provide regulatory protection for a proportion of the exposure. The 2% threshold is in line with that set out in the consultation. Wholesaler bad debt exposure – Ofwat is also proposing to cap wholesaler exposure to bad debt, with the level of the cap to be published in its decision document. In the consultation, Ofwat had alluded to the possibility of protection for wholesalers, and sought further information as to whether a cap was needed. In our opinion, the lower threshold in the deferral proposals hints at a higher risk of delays in customer payments to retailers, and/or heightened bad debt risks vs. initial expectations. Although repayments of deferrals by March 2021 would still be within the current financial year for water companies, the lower threshold will impact cash flow phasing, and the introduction of cap on wholesaler bad debt exposure is therefore a positive for the industry.
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All sites are open: The vast majority of sites have been designated as critical to defence and national security, namely in the US, UK and Norway. Risk of interruption in Australia is low. Most manufacturing sites are remote. >90% order cover: Order placement has continued since the update last month, including a $17m order for F-35 countermeasures. On 29 February, FY20 order cover was 88% and seasonality had reduced, with 28% of FY20E revenue delivered (vs 23%). Progress has been made across all divisions. Cautious cut: We reduce FY20E adj EPS by 7% to reflect: 1) risk of short term revenue deferrals where customer representatives are not able to complete product acceptance procedures, and 2) minor civil exposure. The wide geographic and customer base provides mitigation against further disruption. Financial position: The Group has facilities of almost £150m that mature in October 2022. Current net debt is £84m (vs £86m at end Feb), comprising cash of £33m and drawings under the RCF of £108m. Therefore, available liquidity is approximately £73m. We will review our capex assumptions at H1. Unchanged dividend: The FY19 (Oct y/e) final dividend of 2.4p (£6.7m) was approved at the AGM on 4 March and will be paid on 24 April. There is no mention of the interim dividend that would be announced with results in June. Our view: The shares have fallen 15% ytd and by 30% since the peak in February, which appears an over-reaction. Despite a conservative estimate cut to reflect disruption from COVID-19, a CY20E EV/EBIT of 12x looks attractive given the improving order book, financial position and long term upside potential. The bull case across Countermeasures, Roke and US Sensors remains intact and we point investors to our ‘Path to 400p’ note, published in December.
Good momentum into 2020: Trading to 29 February has been in line with expectations: Order intake increased 10% to £132m, with a book-to-bill of 1.25x implying revenues delivered of £106m, or 28% of INVe FY20E revenue (vs 23% in FY19A). This improvement in seasonality is in addition to better order cover: 88% of FY revenue is under cover (vs 86%). Order Book on 29 Feb of £478m represents a 14% increase on the comparative period. Countermeasures & Energetics: FY order cover of 92% (vs 93%), including, in the period, definitisation of a $98.5m (c.£76m) contract at Countermeasures Australia, and a $50m (c.£38m) order to supply the US Air Force and US Navy; both of which help build cover through FY20E and into FY21E. Sensors & Information: FY order cover of 80% (vs 72%) represents a focus on increasing long-term, high-quality, revenues. A further delivery order of $32m (c.£25m) has been made under the HMDS programme of record IDIQ. Roke has secured its first order for its Resolve Electronic Warfare product, from a US customer, achieving a key strategic objective set for FY20. Net debt of £86m: The increase from 31 Oct’19 represents IFRS 16 adoption. No impact from COVID-19: Given Western defence customers, Chemring does not source any components from China (or North Korea or Iran). Chemring’s markets, led by US defence spending, remain highly supportive. Our view: Chemring is delivering on its strategic plan and continues to improve the quality of the Group. In our December note, we explored the “path to 400p”; given today’s positive update, investors may start to attribute a greater probability to this upside scenario. No changes to estimates. Target Price increased: to 275p (from 245p) reflecting peer group multiples. Interim results are due on 3 June 2020
Ofwat’s PR19 final determinations, published this morning need to be looked at in the round, but we focus on three key components: WACC, totex, and ODIs. Ofwat has set the WACC at 2.92% CPIH real (4.98% nominal) at the wholesale level, with the cost of equity at 4.19%% CPIH real, and the overall cost of debt at 2.14% CPIH real. Our estimates for WACC was 2.94% CPIH real (5% nominal), with a cost of equity of 4.47% CPIH real, and an overall cost of debt of 2.10% CPIH real. (See Figure 1) Totex allowances are broadly unchanged for each of the three listed companies. Severn Trent Water has allowed totex of £6,463m vs. £6,475m as at July’s slow-track draft determinations, South West Water has allowed totex of £1,994m vs. £1,944m, and United Utilities has allowed totex of £5,814m vs. £5,837m. Severn Trent’s Hafren Dyfrdwy’s allowed totex is £166m vs. £164m at draft determination. (See Figure 2) We have compared the key common and bespoke ODIs for the three listed companies to the position set out in April’s fast-track draft determinations. Severn Trent’s ODI RORE range is now -2.83% (P10) to +1.90% (P90) vs. -3.9% (P10) to +1.7% (P90). (See Figure 3) South West Water’s (Pennon’s) ODI RORE range is now -2.12% (P10) to +1.84% (P90) vs. -3.2% (P10) to +1.6% (P90). (See Figure 8) United Utilities’ ODI RORE range is now -1.38% (P10) to +1.21% (P90) vs. -2.3% (P10) to +1.0% (P90). (See Figure 13). We note, however, that July’s slow-track draft determinations had negative implications for United Utilities, so today’s announcement also needs to be viewed in this context. We view today’s announcement as a moderate positive for the listed companies, with the added benefit of an extended period of clarity. For United Utilities, an accelerated shift to CPIH is revenue positive, and should assist in reducing fears over dividend sustainability. Our estimates, target prices and rating for each of Pennon, Severn Trent, and United Utilities are placed under review as we work through the significant detail presented today. Ofwat is hosting a City Briefing on the final determinations at 2pm (GMT) today. This can be accessed via +44 330 336 9411, title: Ofwat City Briefing, code: 3717627.
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FY19 results are in-line with our recently-upgraded forecasts, following the first upgrade to numbers we can remember at the post-close update. Revenue increased 13% and operating profit increased 42%. Adj. EPS increased by 64%. Sensors finished the year strongly, led by the jewel in the crown that is Roke, and Countermeasures has delivered well against targets for a production ramp-up as upgraded sites come back online. A higher quality business: FY19A marks the first year of no exceptionals in over 10 years, which will flag positively on quality screens. Operating cash conversion was 104% (of EBITDA), with working capital discipline being ingrained across the Group. Exiting from non-core, commoditised, energetics businesses is complete, with the quality of the order book now improved. Improvement continuing apace: FY19 was a transformative year, and upgraded and expanded Countermeasures sites will still be in ramp up in FY20. The full benefit of the investment and expansion programme should be seen more clearly in FY21/22, with profitability and cash generation on an upwards trajectory: post-capex cash conversion inflects in FY20E. Longer-term upside in Sensors & Information: We discuss the upside potential from possible further contract wins in US Sensors Programmes of Record. During FY19, further delivery orders were received under the HMDS IDIQ, and the recent order for further AVCAD prototypes increases the probability of a full-rate production award. Re-rating potential: Chemring’s discount to peers is now unwarranted, in our view – operational issues have been fixed and financial performance is being delivered. Our 12m TP is unchanged at 245p, and implies 14x EV/EBIT. BUY.
FY upgrades: We upgrade our FY19E adj. EBIT by 2%, to £43.8m. Sensors & Information benefited from strong trading in the year, ahead of investment planned for FY20. Operational management has improved; given that the period end was yesterday, financial management has also clearly improved vs history, which should inspire greater confidence. We upgrade FY19E adj. EPS by 9%, driven by the underlying operating improvement combined with lower interest from improved intra-period net debt volatility and lower tax due to the geographical mix of profits. Net debt materially better: Improved cash generation, better working capital management and timing of investment, as well as lower-than-expected exceptionals, have resulted in FY19 net debt of £76m, vs our estimate of £92m. We upgrade FY20E net debt by £9m, as approximately half of the FY19E improvement is due to the timing of capex that will now fall next year. This overall improvement results in a FY20E net debt/EBITDA of 1.1x. AVCAD contract milestone: Chemring has received a contract award for 75 prototype units under the US DoD’s AVCAD Program of Record to develop a handheld man-portable, battery-operated, aerosol and vapor detector. This is a clear positive signal and removes uncertainty at the early stages of this competitive programme, where Chemring’s contract is worth c.$800m including options over 10 years. Deliveries are expected to commence during FY20 and while not financially material near-term, we see this as an encouraging sign of progress, de-risking assumptions and improving visibility. Valuation: Our TP increases to 245p (from 225p). Shares are trading on a FY20E P/E 15x, falling to 14x in FY21E, and EV/EBITDA of 9x falling to 8x. We reiterate our BUY.
Chemring Group PLC Resolute Mining Limited
Improved visibility: The order book at 31 August was £480m. This compares to £494m at H1, of which £188m was scheduled for H2 delivery. The number wasn’t quoted at this stage last year. $18m of US Countermeasure delivery orders are also announced today, from framework contracts worth >$200m, which completes the required FY19 order intake in Countermeasures. Sensors & Information: The information security market is buoyant. We recently visited Roke, 15-20% of revenue, and were impressed by its expertise and prospects. It was recently chosen as a prime industrial partner on the UK government’s six-year SERAPIS framework. Deliveries have continued as planned on the Husky Mounted Detection System program, as has work on the Chemical & Biological Programs. These are key drivers of future growth. Countermeasures & Energetics: Recent orders for the US Navy and Air Force provides a strong platform for FY20. Chemring’s position is strengthening. UK Spectral and MTV production lines returned to operation in the third quarter with planned steady state manufacturing expected by year end. A new seven year framework with the UK MOD has been agreed. Australian production resumed and the site is now F-35 qualified. COR is the remaining commoditised business to be exited, where we believe a recent US contract should aide this process. Immaterial estimate changes: We expect consensus FY19 adj EBIT can rise to our estimate. We are 2% above. We marginally improve our FY net debt forecast to £92m from £94m, more than offsetting an FX headwind of c. £2m. Recovery on track: The investment thesis is intact with good progress across the group and improving earnings quality. Our TP increases to 220p, from 200p, to reflect the rise in peer group valuation. BUY reiterated.
Chemring’s H118 report demonstrates improved operational performance and financial security. While FX headwinds persist, the operating margin improvements at Countermeasures and Sensors are visible, as is improved cash generation. End markets are evolving from the perceived threat to increasing budgets, which underpins Chemring’s market position. The FY18 outlook remains unchanged, underpinned by the H2 order book.
Chemring Flash : Building blocks for a step change from 2020
FY17 adj (FD) EPS beat expectations by 9%, due to operational improvement, lower interest and tax. PBT was increased by 30% and net debt reduced by 9%. FY18 has started with 70% order cover. We expect c.4% upgrades to consensus adj EPS, as FX headwinds are offset by further improvements and lower interest. Progress on long-term programmes in Sensors, as well as growth in Countermeasures, should see earnings quality improve. The only wrinkle is an SFO bribery and corruption investigation relating to two historic contracts that CHG selfreported; as has been rife in the sector. 10x CY18 EV/EBIT and a 7% FCF yield are compelling.
Chemring is making strong progress on many fronts as market dynamics begin to play in its favour. It has re-established its financial footing and is positioned to drive growth organically and with selective M&A. FY18 is likely to be one of consolidation due to the profile of the 40mm ammunition contracts, but earnings growth anticipated in Countermeasures and Sensors offsets a fall in Energetics. The operational excellence programme targets a 300bp improvement on existing product lines by 2022.
Times are definitely changing. After Ultra Electronics struck terror in the heart of the UK Aerospace & Defence sector yesterday, Chemring is emerging as the lowest risk stock in the sector. If the MoD is cutting back, we can safely say that Chemring is going to be least affected as its UK revenues (15% of group) are either related to cyber security (structural growth) or consumables (recovering from post-Iraq/Afghan blues). Today, Chemring has issued a year-end trading update which has resulted in a 5% upgrade to our FY17 forecasts. We have no particular reason to increase our FY18 forecasts at this stage but the quality of the order book is improving and our money is on more positive surprises. We would like to see more consistency in free cash conversion before reviewing our target price.
Yesterday marked a turning point in Trump presidency. The “anti-establishment” president who had promised to drain the swamp finally yielded to the US military complex. There are two significant changes in American strategy in Afghanistan and South Asia. The first is a shift from a timebased approach to one based on conditions. In other words, Trump has made an open-ended commitment to stay in Afghanistan. The other significant element of the new strategy is to change the approach to Pakistan, which is now being blamed for harbouring terrorists. As a supplier of short cycle warrelated products (countermeasures, counter-IEDs, pyrotechnics), Chemring should be biggest beneficiary from protracted war in Afghanistan and Pakistan involving increasing number of ground troops.
In recent years, Chemring has been a graveyard for reputations. Today’s interims show that the new FD is leaving nothing to chance but at the same time offering a glimpse of what is possible. For instance, the £20m investment in working capital to improve supplier payments looks like a sensible move if the management wants to achieve operational excellence. There are still shortterm risks to FY2017 such as the requirement to extend the funding on the letter of credit for the 40mm ammunition contract offers. However, we believe that the management has a reasonable chance to become consistently predictable in an "under promise over deliver" way. We raise our TP to 216p reflecting the re-rating of the Aerospace and Defence sector.
Chemring has reported 2016 results modestly ahead of expectations with revenues of £477.1m (2015: £377.3m), an underlying operating profit of £48.5m (2015: £34.4m). Underlying profit before tax increased by 71.7% to £34m, resulting in underlying earnings per share of 10.3p (2015: 7.1p). The closing order book increased by £23.3m during the year and at 31 October 2016 was £592.9m. The Group's net debt at 31 October 2016 was £87.6m (2015: £154.3m). Reflecting the improvement in cash generation and the balance sheet, the company has reinstalled dividend payment and is paying 1.3p.
Our main reservation to becoming a buyer has been removed, profit is converting to cash and the balance sheet looks much stronger. We estimate that in Q4 underlying net cash inflow was £71m after an underlying net cash outflow of £46m in the first nine months of the year. At 31 October 2016, net debt was approximately £88.0m (2015: £154.3m). On a constant currency basis this figure would have been approximately £65m. Net debt at 31 July 2016 was £147.0m, of which £11.3m relates to the translation of US dollar denominated debt. The ratio of net debt to underlying EBITDA is well within the group’s target range of 1-1.5x. We raise our recommendation to BUY with a target price of 175p.
We have reviewed our financial model following the Q3 update and a conversation with outgoing FD. With less than two months trading left, the company is confident of meeting FY expectations, albeit with some help from FX. We have raised our forecasts but stay below consensus mindful of the fact that the final quarter to October is expected to be the most productive period for the company in terms of revenues, profits and cash flow. For us, cash flow is critical given that the primary driver of share performance in the past year has been the weakness in the balance sheet. If we are to believe the consensus then the total net cash inflow in Q4 will total around £57-59m after an underlying net cash outflow of £46m, excluding the rights issue proceeds of £76m and FX impact of £22m, in the first three quarters of FY16. With the majority of US collections expected in Q4, the management is confident of achieving this target. We raise our target price by 27% to 136p reflecting the 13% increase in FY16 EPS forecast and the rerating of the sector from 13.9x to 14.6x since the middle of July.
Chemring hosted a lunch yesterday for analysts and I got the opportunity to speak with various members of the senior management. The key takeaway for me was that things are going according to plan but there are no obvious upside risks. Middle East markets remain quiet. The US presidential election still appears to be the main catalyst for a change in sentiment. The general opinion was that both Clinton and Trump would be a positive but in different ways. Clinton is expected to remove some of Obama’s constraints on defence budgets. Trump, on the other hand, is expected to free up more export markets.
The management have left themselves with a big ask in H2/16 to deliver on FY16 expectations even after the c3% downgrade yesterday. To meet the revised FY16 expectation, H2/16 revenues needs to grow by 48% sequentially while operating margins are expected to grow nearly 8-fold to 16%. While the first task looks more attainable, the second relies on everything going to plan. Recent history suggests caution, extreme caution. However, yesterday’s 18% fall has brought the share price closer to our target of 107p, equivalent to sector rating of 13.9x FY16 PG EPS forecast. Hence, we are moving our recommendation from SELL to HOLD.
Our meeting with the Finance Director yesterday generated energetic use of pen and keyboard skills but left our headline numbers and thoughts largely unmoved. We acknowledge self-help measures but this is not enough to allay the primary concern over the quality of the order book and risk of further disappointments. Converting some orders into timely revenues and cash remains a challenge, while low oil revenues are pushing out export wins. Like FY15, we are again relying on a strong H2 to deliver expectations assuming there are no more delays in customer acceptances, issues in supply chain, etc. While the financial markets reacted positively to last week’s update on the 40mm order, to us it only served to highlight the fragility of forecasts. This brings us to back to where we started with our BUY initiation in August 2014 – a protracted conflict involving the US and allied ground troops will be instrumental to changing Chemring’s rating. The foreign policy of the next US president could be the catalyst. Ted Cruz anyone?
The shares jumped 4% yesterday following news that the Pentagon has awarded Chemring Military and Alliant Techsystems a five-year firm-fixed-price contract worth $750m for non-standard ammunition and non-standard mortar weapon systems. While we have upgraded our revenue forecasts, we have cut our EPS forecast by 16% due to the continuing delay on receiving advance payment on the 40mm Middle East ammunition order. We also expect higher interest charges due to the sharp increase in operating cash outflows in the first quarter of FY2016, which along with the weakness in sterling against the dollar, is slowing down efforts to reduce net debt. We are cutting our target price to 107p (115p).
The collapse in the oil price is clearly starting to take its toll on Mid-East defence spending. While the management is sticking to its FY2016 outlook, trading since the start of the fiscal year has been below management's expectations. The company is again hoping for a better H2. The rights issue of £80.8m which will raise net just £75m will be used to cut net debt of £154m at end-Oct.
The stock has recovered over half the losses following the profit warning on 27th October. If this recovery is due to positive newsflow on defence spending following the Paris attacks, then we believe the market will be disappointed. More airstrikes will not drive Chemring's earnings; that requires boots on the ground for which there appears to be no political will. Before 27th October, we were Buyers on the grounds that at 15x FY2015 EPS the stock offered a cheap option on potential for troops on the ground. However, the profit warning and the planned rights issue in Q1/16 has greatly diluted EPS potential. The valuation now looks very stretched at 21x FY2016 EPS and the company is still in discussions with banks and loan note holders in relation to amending covenants.
The transition of value from capital intensive, production activity towards consumption-based cyclicals continues apace. Commodity price falls have provided a significant, if squally tailwind to service-based developed economies. The addition of Trinity Mirror (TNI.L) and Just Eat (JE.L) to our Conviction Buy list reflects attractive individual investment cases but also the strength of UK-based consumption growth. Real wage increases, affordable credit and decade-high consumer confidence presents an attractive domestic backdrop. By contrast Chemring (CHG.L) has had to face up to the termination of non-standard ammunition contract from the US government and delays to HDMS orders from a Middle East customer. We have removed it from our Conviction List.
CHG JE/ RCH
We are removing Chemring from our conviction BUY list following a poorly handled trading update and balance sheet restructuring this week. Ultimately, we sense a sudden lack of confidence in the £606m order book and profit prospects for 2016 and beyond. Yes, £90m should be enough to stabilise the balance sheet. Our calculations show that EBITDA would need to fall by more than 45% in FY16 to break covenants. However, yesterday's announcement has put heavy demands on the valuation, particularly as confidence has been shaken. At 18x 2016 EPS the stock is trading well above UK peers at 12-15x. Our target price of 115p puts Chemring at the bottom of this range.
Chemring has announced another profit warning, but unlike previously, management appears to be finally setting about rebasing the company for the future. While FY16 expectations look relatively intact, with 75% order book cover for revenues, a standby rights issue should see debt reduce to manageable levels, enabling management to stop looking over its shoulder and focus on the path ahead. Such repositioning should come as a welcome relief to investors.
Timing is everything. While the decision to shore up the balance sheet is perfectly sensible, this advice would have been more apt in in mid-September when the company announced that expectations were unchanged. Yesterday, it looked exactly like it was: a classic textbook reaction to a crisis. Ultimately, we sense a sudden lack of confidence in the £606m order book and profit prospects for 2016 and beyond. Yes, £90m should be enough to stabilise the balance sheet. Our calculations show that EBITDA will need to fall by more than 45% in FY16 to break covenants. However, yesterday's announcement has put heavy demands on the valuation, particularly as confidence has been shaken. At 18x 2016 EPS the stock is trading well above UK peers at 12-15x. Our new target price of 115p (140p) puts Chemring at the bottom of this range.
The company has warned of delays to revenues from the 40mm ammunition contract announced on 14 September 2015. As a result, it now expects operating profit to be reduced by around £16m to £33m. The main issue for us is the balance sheet as the company has warned that discussions will be held with debt providers to negotiate amendments to the operation of covenants and the waiver of any event of default that may result from the 40mm contract delay. Our best guess at this stage is that the shares will fall to EV of around 1x2016 Sales of £450m, equivalent to 140p. We move our recommendation from BUY to SELL.
Our Buy case has been predicated on two factors: an end to profit warnings plus the added spice of renewed US-led conflicts. The first factor appears to have been accomplished; the second may not be necessary for positive surprises. Indeed, orders are rising even without a major campaign involving the DoD and MoD. In recent years, a delay here and a cancellation there would normally constitute a profit warning. However, as today's trading update shows the company is now much more resilient. The renewed focus on the top line under the new CEO and the benefits of an efficiency drive has meant there has been no change to FY2015 EPS consensus of around 14p since July 2014. We expect FY2016 consensus forecast of 16.5p to be upgraded in the next two quarters even if there are no US or British troops on a Middle East ground.
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