The Cheapness of Chemring

Saturday, Nov 03 2012 by

Another profit warning from Chemring (LON:CHG) caused its shares to plunge by some 17% this week, and although trying to catch a falling knife is usually as dangerous as the products made by the company, its growth over the last decade makes it worth a closer look.

Chemring is a defence company with a market capitalisation of £536m, placing it in the FTSE250. The group specialises in the manufacture of energetic material products and countermeasures and provides solutions in defence, security and safety markets. They are involved in advanced development programmes in the UK, USA, Europe and Australia and operate in four market sectors: Counter-IED, Countermeasures, Pyrotechnics and Munitions. As a result of the growth in threat detection systems, electronics now represents 40% of their revenues and the long-term strategy is to maintain a balance between high technology electronics and energetic products.

Over the 10 years from 2002 to 2011 the company appears to have gone from strength to strength with compounded annual growth rates as follows: revenue 25%; adjusted EPS 37%; basic EPS at 33%; and dividends per share at 31%.

CHG 10 Year Revenue, Earnings & Dividends

Had £1,000 been invested in the company at the start of the period it would have been worth £11,873 at the end of the 10 years with dividends reinvested: an annualised total return of 28% (source: Chemring).

But good things don’t last forever…

Despite the excellent long term record of the company, 2011/12 has been much more difficult and the defence sector generally has struggled with government budget cuts which has either seen orders cancelled or delayed. But it appears that Chemring’s management have failed to adequately forecast the disruption to its business and have continued to reduce profit expectations as the financial year progressed. The market was therefore taken by surprise by the end of year trading statement on Thursday which delivered the knock out blow:

…the Group has reduced its expectations for its earnings per share for the financial year ended 31 October 2012 by 13 pence.”

The announcement cited 3 principal reasons for the reduction: (1) delays in the granting of some export licences regarding a contract to supply a Middle Eastern customer with vehicle based mortar systems; (2) delay in the receipt…

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Chemring Group PLC is engaged in offering solutions to protect defense and security markets. The Company operates through three segments: Countermeasures, which is engaged in the development and manufacture of expendable countermeasures for air, sea and land platforms, and land-based electronic warfare equipment; Sensors & Electronics, which is engaged in the development and manufacture of improvised explosive device (IED) detection equipment, chemical and biological threat detection equipment, IED electronic countermeasures, network protection technologies and explosive ordnance disposal equipment, and Energetic Systems, which is engaged in the development, procurement and manufacture of signals and illumination devices and payloads, cartridge/propellant actuated devices, pyrotechnic devices for satellite launch and deployment, missile and ammunition components, propellants, warheads, fuses, separation sub-systems, actuators and energetic materials. more »

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3 Comments on this Article show/hide all

Miserly Investor 8th Nov '12 1 of 3

Yesterday, on 7th November, Carlyle Group walked away from the bid discussions - see the announcement here:

That coincided with the result of the US presidential election and further concern over the outlook for defence spending.

Since the article was published at the weekend the share price has fallen back a further 13%. The price now looks incredibly cheap on the fundamentals: is this the perfect time of maximum pessimism or is the market correctly factoring in a very bleak few years for CHG? The key thing as ever for income investors is sustainability of the dividend through this difficult period.

The next update from the company is on 27th November with the prelims expected on 24th January. Will there be any more surprises on earnings?

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Fangorn 8th Nov '12 2 of 3

Hi Miserly,

I suspect another profit warning will be in the offing myself. Carlyle walking away says it all imo. They were unable to justify paying well over where it is currently trading given the potential pitfalls and likely earnings disappointments.

Interesting to see though that CS still have a TP 340p on this one, despite reducing to a "neutral" rating.

They highlight Chem being particularly vulnerable to US Sequestration - odds on this, who knows. Add to this the dissipation of the "takeover froth" from the collapse of the bid (and the unlikely materialisation of another bid in the foreseeable future) and its easy to see why this one has fallen back as much as it has.

Short term I expect it to drift in the run up to 27th Nov update. Only 20 days away. Coupled to a generally weak market, with any excuse to take fright and lop 15-20% of a company's stock price if there's any earnings disappointment,  I'd be inclined to wait till earnings day myself.
Broker snap: Little chance of another bid for Chemring, says Credit Suisse

If earnings come in flat on 27th Nov I'd personally tuck some away at current levels (if it is still trading around 240-250's at that point that is)

However should there be another profit warning then expect 15-20% fall from 240.

As to my own personal situation. Should it fall 15% in the interim I'd certainly tuck some away for a LTBH in the expectation that, at some point, management will turn things around (and the belief that Sequestration wont actually occur)

Certainly am following this one closely at the moment. As indeed I continue to do so at BAE.

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Miserly Investor 12th Nov '12 3 of 3

And the defence sector continues to be beaten down – this time by Cobham's cautious outlook in its interim management statement:

The market has reacted with a 10% fall in COB’s price at the time of writing. Although it is interesting to note at the end that management reiterate their commitment to a 10% annual dividend increase. COB has been a dividend raising star since, I believe, the 1960’s.

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