Chemring higher after targets upgrade

With President Trump signing off the largest military budget in US history — at an incredible $700 billion for 2019 — there’s good reason to think that Chemring shares are well placed to keep moving in the right direction.

The defence stock surely won't quintuple like it did from 2005 to 2008, but the City's £50 million-plus profits forecast for 2020 has been enough to get analysts predicting that shares will at least rebound to the 250p mark.

Two years ago, they were down at 117p, with Chemring having found itself too exposed to the swings in sentiment caused by the defence spending plans of various governments. An £80 million rights issue was required to cut debt, while Australian CEO Michael Flowers set about reducing costs and building a more sustainable foundation for growth.

Source: interactive investor      Past performance is not a guide to future performance

That restructuring phase is now complete, with Flowers proud to call Chemring a much more "boring" company. There’s now less reliance on volatile, commoditised contracts, with a focus instead on growing the higher margin areas in the portfolio. The target for 2022 is to achieve operating margins of 13%, compared with 10% in 2017.

Nowhere is this ambition more evident than in Sensors, where Chemring's technology helps to detect explosive, chemical, biological, radio and cyber threats.

This division is on the cusp of some major deals involving technology across four US-based programs, although these are dependent on ongoing testing and protracted customer-decision making processes.

Sensors accounts for 20-25% of the group, but Flowers predicts there's long-term potential for this to grow to a third. That's similar to the anticipated ratio for Countermeasures, in which Chemring is the world leader and the beneficiary of some improving market conditions, particularly in the United States.

Countermeasures, which protects aircraft and ships from guided missile attack, is the sole supplier of F-35 and Typhoon flares. The division accounts for more than a 50% share of the global market and is what Flowers describes as the "heart and soul" of Chemring.

Energetics is Chemring's third and biggest division by revenues, with functions ranging from aircraft ejection seat propulsion to the illumination of battlefields. 

Half-year results today showed that revenues in this division, which tends to be lower margin, fell by 17.3% with profits down 50%. Across the group, revenues fell 8% to £229.3 million, but with underlying earnings per share up 28% to 4.1p.  The interim dividend rose by 10% to 1.1p.

Analysts at Peel Hunt and Investec Securities agree that Chemring is moving in the right direction, but warn that much will depend on the Sensors contracts.

Source: interactive investor      Past performance is not a guide to future performance

Peel Hunt’s Henry Carver increased his target price by 30p to 240p based on a projected 2019 price earnings multiple of 17.6x and a dividend yield of 1.6%.

He said: "Chemring's investment case rests on a handful of large long-term opportunities, particularly within Sensors, which are still at early stage and therefore come with a degree of execution risk.

"However, these have all continued to progress this year and our confidence in them has increased accordingly."

Upgrading his price target to 250p from 240p, Investec's Chris Dyett noted improved margins in countermeasures and higher quality earnings in energetics.

He added: "The interims are modestly ahead of our expectations, reflecting the progress made in recent years in rebalancing and improving the quality of earnings."

Flowers is standing down at the end of this month after four years in the post and 13 years at Chemring in total. He will be replaced by Michael Ord, who previously worked at BAE Systems.

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