Shares of defence and aerospace firm Cobham (LSE: COB) fell by 20% on Thursday, after the group issued its fifth profit warning in 15 months. The shares have now fallen by 68% since early 2015.
Shareholders will be desperate for signs that the firm’s decline has bottomed out. Potential buyers — including me — will be trying to decide whether this latest round of bad news is likely to be the last.
What’s new?
Thursday’s update contained bad news on almost all fronts. Higher costs and bad debt charges mean that underlying trading profit for last year will be £225m, £20m less than the firm’s January guidance.
Cobham has also booked an additional £150m charge relating to an airborne tanker project it’s working on with Boeing.
The firm’s balance sheet review has unearthed more problems. Cobham will write off a total of £574m in goodwill and intangible fixed assets. These are non-cash charges and mostly relate to acquisitions made between 2009 and 2014. The biggest culprit is the 2014 Aeroflex acquisition, which was probably the trigger for the firm’s current problems.
Although these are non-cash charges, they are bad news for shareholders because they mean that previous management has effectively wasted more than half a billion pounds of company cash.
Unsurprisingly, this has left Cobham with a debt problem. The firm admits that at £1bn, net debt is too high and that action will be required to strengthen the balance sheet. I’d expect a rights issue to be the most likely outcome, but further guidance will be provided with the firm’s results at the start of March.
The good news
The good news is that this update has been issued after the firm’s new chief executive and chief financial officer — David Lockwood and David Mellors — have had time to review the firm’s balance sheet, contracts and funding position.
In my opinion, this update is a proper kitchen sink job. All of the firm’s problems should now be out in the open. Unless Cobham’s core businesses have fundamental issues, the group should now be able to work towards a recovery.
Cobham has gone onto my watch list. I’ll be studying its results carefully in March for signs of value.
This is how it should be done
Cobham isn’t the only defence firm with problems. Smaller peer Chemring (LSE: CHG) raised £80.8m in a rights issue last year, after profits slumped and debt levels became unsustainable.
Shareholders had endured a decline that saw the value of their stock fall from 722p in 2011 to just 90p last year. However, Chemring’s turnaround appears to have been successful. The firm’s recent results suggest to me that this stock could be an attractive buy at current levels.
Underlying earnings rose by 45% to 10.3p per share last year, putting the stock on a P/E of 18. Although this may not seem cheap, earnings are expected to rise by about 10% in both 2016/17 and 2017/18. Dividends should also rise now that debt levels are under control.
Although a partial recovery is already priced into Chemring stock, I think there’s a good chance that it will outperform expectations. I’d remain a buyer at under 200p.
