|
Recommendations: 18
After a bit of an investigation into this share I've recently decided to buy in and thought I'd share for discussion with other investors.
The Numbers:
Price: 517.50p
Market Cap: £1,004.8m
2010 P/E: 10.65 (before exceptionals) 13.7 (after exceptionals)
Forward 2011 P/E: 8.7
Yield: 2.28%
Forward yield: 2.7%
PBV: 2.24
ROE: 26.9% (before exceptionals) 21.6% (after exceptionals)
Current ratio: 2.06
Interest cover: 7.17
Dividend cover: 4.12
What do they do?:
Industry: Aerospace & Defense
"Chemring Group PLC, along with its subsidiaries, is engaged in the design, manufacture and sale of countermeasures, counter-improvised explosive device (IED) equipment, pyrotechnics and munitions. It has four segments: Countermeasures, which involves expendable active and passive countermeasures for naval and air platforms, land-based electronic warfare (EW) equipment; Counter-IED, which is engaged in the IED detection equipment, IED electronic countermeasures, explosive ordnance disposal equipment and demilitarization services; Pyrotechnics, which invovles the signals and illumination devices and payloads, cartridge/propellant actuated devices and pyrotechnic devices, and Munitions, which involves missile and ammunition components, propellants, warheads, fuzes, energetic materials, medium and caliber ammunition."
Rather than repeat too much, I recommend reading this "Introduction to Chemring" presentation from their website, although I'll touch on some key points in my investment case:
http://www.chemring.co.uk/~/media/Files/C/Chemring/PDFs/intr...
Investment case:
This is a company that has shown explosive growth in recent times with a 5 year CAGR in revenues of 38% but currently trades on a P/E of that of a low growth company. The expansion has been driven by both organic growth but also an acquisition-driven strategy and it has paid off very well for shareholders - even after recent falls it's been a 12-bagger since the beginning of 2000, excluding dividends, although since 2008 the rate of share price appreciation has fallen significantly. Expansion has been financed by a mixture of retained earnings, debt & equity issuance and although I typically hate equity dilution it does appear that management have re-invested these funds well for the benefit of all shareholders.
£430m has been spent on acquisitions since 2005 although management stress the importance of acquiring at a reasonable price - always nice to hear! They've paid between 9x and 16x profit for their acquistions so it looks like they've been prudent with shareholder funds.
Product wise they are involved in 4 main areas of defence - Pyrotechnics (29% of revs), Counter-IED (19% of revs), Munitions (19% of revs) & Countermeasures (33% of revs). Of these, they have most market share in Countermeasures (47%) and Pyrotechnics (10-20%) with small market shares in the other two categories. Their biggest customer is the US government who supply 49% of their revenues, followed next by the UK (19%).
Their strategy is to become the market leader in the niche areas of defense in which they operate. They claim the Pyrotechnic and Counter-IED markets in particular are highly fragmented and see the benefits of consolidation under these areas through acquisition of the smaller players and then integration with the business to realise synergies.
The current main fear I can see surrounding this stock is the high exposure of the defense industry to potential cuts. However, Chemring claim they are better positioned than most defense companies as they produce more relatively small-ticket items that need constant replacing rather than large discretionary items like tanks, fighter jets etc that are more like to be the ones most affected by spending cuts. Offsetting this of course is the growth which they expect to come both from further acquisition and consolidation, branching out their customer base to other countries and also further organic growth.
There has been recent director purchasing from the Chairman for ~£100k worth of shares at ~£5. The CEO bought £28k in June. From my own calculations, the CEO owns a bit more than £3m worth of shares at current market price and his total renumeration last year was ~£850k. The CFO owns about £1m worth of shares at current market price compared to annual total renumeration of £525k. Note that both the CFO and CEO sold ~£300k worth of shares each in January due to an exercise & partial sale of share options, both sold less shares than they received in options.
The Interim Management report on the 30th August shows revenues up >30% YoY with the order book up 43% YoY (the order book is largely for orders <12 months out, so looks good for continued growth into next year); management expect to meet financial expectations for the full year.
TLDR version: A rapidly growing company in an unloved sector on a low P/E with competent management who have a history of delivering for shareholders.
Well, that's my current thoughts/knowledge on Chemring. Does anyone else have any deeper insight into this share? To be honest I don't know the defense sector well at all so have only gotten the management's obviously biased views of things but given how cheap the shares look on a numbers basis and given the rest of the quite positive investment case I've decided to buy in.
P.S. Just decided to do a quick search on the boards for Chemring and found DoY's post in the GARP forums on it, well worth a look too:
http://boards.fool.co.uk/chemring-chg-11843705.aspx?sort=who...
DYOR etc!
Mark
|
Recommendations: 2
This is a company that has shown explosive growth
Genius pun!
|
Recommendations: 0
Ahaha, didn't even intend that one!
|
Recommendations: 5
Recommendations: 1
Recommendations: 6
The statement is here...
http://www.chemring.co.uk/media/press-releases/2011/2011-11-...
Obviously the markets are going to react negatively to any confirmation of market uncertainty and order dealys caused by Government cutbacks in defence spending. In addition, Chemring is also somewhat correlated with the global security situation.
Before, getting to that I would take a look at this comment
The Group’s order book at the end of the year was £878 million, which is 9% higher than at the end of 2010, but 12% lower than reported in our third quarter interim management statement. This reflects widespread delays in the placement of contracts because of the continued uncertainty in the US and European defence markets, as well as the impact of the timing of religious festivals with our Middle East customers
Aa a result of the £37m order slipping into November, does this mean that the £878m figure includes the £37m order? It's a question worth asking IMHO.
Industry slowdowns always start with order delays, then cancellations, then earnings downgrades. Clearly the market doesn't believe in the argument that this is a temporary delay which will cause 2012 to be second half weighted. Especially, when they say this..
The European market continues to be dominated by government deficit reduction programmes, which are expected to generate further short-term uncertainty in European defence budgets and disrupt current procurement plans. Over the next twelve months, we expect this uncertainty to translate into weaker defence spending and delays to the traditional timing of the placement of orders.
Given the current enironment, I think there is downside risk here.
Perhaps an idea would be to monitor other companies in the sector on an ongoing basis and see if they start talking about a pick up in demand? For example, I listened to Agilent's conference call the other day. They are diversified across a number of industry verticals. They gave a negative tone to the outlook for defence spending.
HTH
|
Recommendations: 1
Hey SG,
See your point re: the industry slowdown. The near-term prospects for the industry don't look good but I'd argue that surely the price is already so discounted due to this that there's a significant margin of safety for things to go quite badly already? If I wait for everything to look rosy, surely the price will have already gone up significantly? I'm happy so long as this is cyclical weakness rather than structural weakness as I'm willing to sit patiently until the world recovers.
Assuming basically zero growth in profits from last year the company is on a P/E of about 8.5 which to me implies the market is already anticipating significant negative growth for this company and anything better than this is surely a bonus?
Also, couldn't short/medium-term defense market weakness potentially allow the company to make a number of acquisitions at depressed prices, setting them up well for their longer-term growth strategy?
Mark
|
Recommendations: 8
Mark,
I think you've struck upon one of the hardest issues in investing. Your style of investing is more in tune with the value based investors on this board than a Growth orientated one like myself. So I suspect the investment heuristics that you will have developed will have more in common with them than me.
To put this into english, lets look at the proposition here..
1. Let's assume that you share my opinion that there is a high possibility that Chemring is not going to meet its 2012 targets and the 'second half weighted' argument is in fact wishful thinking on behalf of the board. This means that you are holding a stock that is likely to tell the market something it doesn't want to hear later on.
2. You feel that the stock is great value even if it gives flat results for 2012. And even if this is below what they are targetting for 2012.
So what do you do in this situation?
A growth investor whould tend to shy away from 1 and not even get to 2. A value investor would tend to ignore 1 and analyse 2 first. Perhaps a balanced approach would be to accept the valuation attraction and consider the long term prospects and drivers for the business.
Its been a great ten years of Chemring with a succession of military conflicts involving their customer basis, similarly their solutions are in the areas where defense departments want to shift their spending. Moreover, they are expanding their share of revenues from non-Western countries in order to catch growth. On the downside, their current customer base is clearly under pressure to cut defence budgets and spending tends to happen in multi-year cycles. Much of this-as you've seen with the States just recently- has not even been decided yet and the pressure is downwards not upwards.
My hunch would be that its best to wait and see developments and I'd be more tempted to buy in if they had 'kitchen sinked' it in this statement. This isn't just about investor sentiment after a future reduction in guidance. If they really believe that they are going to hit 2012 targets, than this will have an affect on their inventory build, capex and operating costs etc.
But hey, I guess a value investor would have a bunch of these situations, some of which will work, some won't. An investment in Chemring might make sense from an overall portfolio perspective to them.
|
Recommendations: 0
Wow, some really interesting food for thought here. I've been mulling it over for a day and still can't exactly decide where I sit.
Kind of reminds me of chapter 12 in Keynes' 'The General Theory of Employment, Interest and Money' where he discusses market behaviour in general and argues that it's perfectly rational to not buy an investment at £25 that you believe to be worth £30 if you also believe you'll be able to buy it for £20 in the future. I see your argument that by not 'kitchen sinking' expectations as it were Chemring have set themselves up to potentially dissapoint again in the future and it'd be foolish (and not the good kind of 'foolish'!) to expect that a company that is utterly reliant on a small group of customers in similar financial troubles not to be under a lot of pricing & demand pressure in the medium term.
Having said that I'd imagine the big spending cuts will surely come mainly in killing big discretionary spend (your tanks & planes etc) rather than not buying counter-measures & munitions etc (btw your comment "similarly their solutions are in the areas where defense departments want to shift their spending" <-- do you mean shift to or from this area?) and Chemring's expansion plans should hopefully offset some of this. Director buying is nice too although they could be excessively optimistic about the business's current prospects which could even be a negative if they overspend on inventory, capex etc.
On balance I've decided to heed your advice and hold back some funds in this situation and see how things pan out - if the price tanks some more I can consider whether to top up and if things being looking rosy again and the price rises then my current holding benefits.
Thanks very much again for the feedback SG, very useful to a novice like me!
Mark
|
Recommendations: 2
One year on the new CEO (started 5th November) does kitchen sink it:
The Group's performance during 2012 was extremely disappointing. Chemring's operational performance has been weak, and management of investors' expectations over the past year has also been poor. In part, this resulted from a failure to anticipate the likely impact of the changing market dynamics on the Group's businesses, but also reflected failures in performance at several of our businesses.
...
Defence spending in the US, UK and Europe is expected to remain under significant pressure.
The US defence market remains vulnerable to ongoing budget uncertainties, particularly around sequestration and the impact of a six month continuing resolution from 1 October 2012. The threat of sequestration continues to have a negative impact on customer behaviour, and there is a lack of clarity about defence expenditure in the medium term.
...
The UK MoD's review of its procurement process continues to result in delays to the start of new programmes and reduced funding for existing ones whilst, in Europe, ongoing deficit reduction programmes are exerting downward pressure on defence spending, leading to uncertainty in the procurement process and delayed programme implementation.
Chemring's non-NATO markets continue to offer opportunities, although order intake remains subject to the granting of export licence approval, which is proving more difficult to achieve in some markets.
manzanilla
|
|
|
