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Questor: going on the offensive in the defence industry makes Chemring a valuable ally
Questor share tip: the military countermeasures specialist is recovering well from a difficult year
Donald Trump has expressed concern over the $120bn (£95bn) merger between United Technologies and Raytheon to create the world’s second-largest defence contractor behind Boeing. If the firms’ biggest customer is worried about facing a squeeze from a deal that brings together Tomahawk cruise missiles and Pratt & Whitney aero engines, then how must some of the pair’s smaller suppliers be feeling? After all, the hoped-for $1bn of annual cost synergies by year four have to come from somewhere.
Another round of consolidation is enough to send the emergency flares up over the sector. One company adept at doing just that is Chemring, the Hampshire-based defence contractor that traces its roots back more than a century and originally manufactured and installed kit that enabled Britain’s street lights to be switched from gas to electricity.
These days it is better known for so-called countermeasures, supplying RAF Typhoons with flares, decoys and “chaff”, the clouds of small pieces of aluminium or glass fibre that confuse radar and distract missiles. This activity accounts for about 70pc of group sales, together with energetics, which makes aircraft safety components and missile self-destruct systems.
More recently, Chemring has been famous for things going wrong. Last summer an employee died after an explosion at its Salisbury facility. The Health & Safety Executive is still looking into what happened and production has been gradually brought back on stream. Elsewhere, equipment failure at plants in Tennessee and Norway led to further disruption.
What it wants to be celebrated for is the remainder of the business, the sensors and information division where revenues were up by a quarter at the half-year stage to £54m as landing a place on several US defence programmes started to pay off.
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Chemring detects and defeats chemical, biological and explosive threats including through Juno, a handheld device that spots signs of suspect vapours. Its Roke operation, whose clients include Raytheon, offers a range of cyber security services and should be boosted so that it can capitalise in a booming market. Overall, the US accounts for just less than half of group revenue.
Chemring has a heavyweight management. The chairman for the past three years has been former BMW and General Motors executive Carl‑Peter Forster and about to mark his first anniversary as chief executive is BAE Systems veteran Michael Ord.
Ord’s plan – as well as making Chemring less accident-prone – is to reshape the business around higher-margin, longer-term contracts, which should please shareholders put through the wringer lately. Company watchers at Stifel, the broker, estimate that there is another $70m of moderately loss-making businesses based in Florida and Derby to exit as Ord offloads commoditised activities.
In addition to overhauling his top team, he is trying to plot a path to £500m of revenues within five years – from about £350m this year – and £75m of earnings.
That ambition looks more realistic as the order book swelled to £494m at the half-year stage, a third higher than at the same point last year, thanks in part to new contracts worth $67m for Chemring’s Australian subsidiary with the US Department of Defense to supply countermeasures to the Royal Australian Air Force, US Navy and Foreign Military Sales in support of the F‑35 joint strike fighter.
Given the recent problems and need to improve safety as well as the dash for growth, investment is being increased. Capital expenditure will more than double this year and next to around £50m.
House broker Investec thinks the company will earn 72pc of its operating profit in the second half, compared with the expectation of 85pc at the start of the year. The main reason is the early recovery of £13m in insurance money related to the Salisbury incident.
The shares are starting to show signs of life. It is always a risk investing in a firm still on the road to recovery, but Chemring is bullish about its prospects. The shares are trading on 14.2 times forecast earnings for the current financial year, which runs to the end of October, and 10.6 times next year. Worth buying.
Questor says: buy
Ticker: CHG
Share price at close: 170.2p
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