Security company ArmorGroup could profit from increasing instability round the world.
For the last two years holding shares in security company ArmorGroup
has been a white knuckle ride. The shares fell from a peak of 250p in July 2005 to just 53.5p last November as forecasts were slashed due to contract delays and increased competition.
However, I think that the company, which provides armed and unarmed security services, may now be on the turn. That's partly because ARG's Iraq business may do better (49% of sales came from Iraq last year), and partly because ARG is diversifying its revenue away from that country.
Let's look at Iraq first.
The Iraqi government recently passed legislation that creates a framework for the reconstruction of the country's oil and gas industry. Iraq has the second largest oil reserves after Saudi Arabia and rebuilding this sector of the economy is going to be a mammoth task. Multinationals involved in reconstruction will require extensive security and ARG is as one of the "go-to" companies in the country.
What's more, at some point the US will start withdrawing troops. This will be a substantial logistical challenge, as a lot of equipment will have to be sent back to the US. This kit will be transported in large convoys along Iraq's roads to the main ports in the south and require plenty of protection from armed insurgents.
The outlook in the rest of the world is also good. The reconstruction effort in Afghanistan will need high levels of security. ARG has a countrywide presence with a large base in Kabul and will profit as contracts get awarded to rebuild the country's infrastructure.
Elsewhere, attacks on foreign oil companies have increased in the last year in Nigeria and Algeria. And the recent kidnapping of British Embassy officials in Ethiopia underlines the security problems facing companies operating in unstable parts of the world.
In addition to an improved operating outlook, the financials look sound. The company generated some £15m of operating cashflow in the last year, equivalent to 30% of its market capitalisation, thanks to improved working capital and a large depreciation charge.
There is also scope for margins to improve. Last year, the company said that margins had been depressed by the under utilisation of its training facility in Iraq due to a slowdown in coalition funding. In addition, the company believes that it can support extra revenue growth with little fixed cost investment.
According to Hemscott, the house broker has a forecast of EPS of 8.4p for the financial year ending December 2007, giving an undemanding p/e of just 11. This may seem harsh for a company with potentially great growth prospects but reflects a lack of confidence in a management team that has not delivered on profit forecasts.
There are certainly risks to investing in ARG, namely the timing of contracts, the volatile environments in which it operates (especially Iraq), and the high fixed cost base. That said, if the company can deliver on expectations then there is scope for the shares to be re-rated.
John owns shares in ArmorGroup.