In my experience as a former senior investment bank trader and longtime private investor the FTSE 250 is a good place to find tomorrow’s stars today.
This could well be the case with high-tech defence firm Chemring (LSE: CHG), in my view. Its core capabilities include latest technology systems for active cyber defence, electronic warfare, and aerial and naval countermeasures, among others.
It is a global leader in countermeasures systems, supplying 85% of NATO’s air fleets and 60% of its naval fleets. It is a key supplier of precision technology to NASA and SpaceX, providing 230 products to the Mars Perseverance mission alone. And it is a ‘trusted supplier’ to the UK Ministry of Defence on a range of cyber defence and other systems.
An increasingly dangerous world?
Irrespective of any peace deal reached in Ukraine, I think Russia will keep testing NATO’s eastern flank.
This could not come at a worse time for the European members of this security alliance. US President Donald Trump has made it clear that his country will not defend any member not contributing sufficiently to its defence.
The figure he most often mentions is 5% of their gross domestic product (GDP). In 2024, the average spend was 2% of GDP.
Consequently, the European Commission announced in March that a new €800bn (£670bn) defence fund will be established. Shortly afterwards Germany exempted defence spending from its federal debt rules, potentially freeing up unlimited euros of additional funding.
Given its ongoing work with NATO and with the US Department of Defense, Chemring looks ideally placed to benefit from this environment.
How does the core business look?
A risk to the firm is a major malfunction in one of its systems that might be costly to fix and damaging to its reputation.
However, its revenue increased 8% year on year to £510.4m in 2024. Operating profit leapt 28% to £58.1m. And its order book hit an all-time high of £1.038bn – a rise of 13% on the year.
Analysts forecast its earnings will increase by 18% a year to the end of 2027. And it is precisely this growth that powers a firm’s share price over time.
Chemring is targeting around £1bn of revenue by 2030. Revenue is the total income made by a firm while earnings are what remain after expenses have been deducted.
What might this mean for the share price?
The firm’s 24.5 price-to-earnings ratio is undervalued against its peer group’s average of 27.1. These firms comprise Northrop Grumman at 18.7, BAE Systems at 26.3, L3 Harris Technologies at 27.3, and RTX at 36.
It is also undervalued on the price-to-book ratio, at which it trades at 2.9 compared to a 3.6 average of its competitors.
I ran a discounted cash flow analysis to find out what this all means in share price terms.
Using other analysts’ numbers and my own, this shows Chemring shares are 45% undervalued at their current £3.78. Therefore, their fair value is £6.87, although shares go down and up in value.
Will I buy the stock?
I already hold BAE Systems and Rolls-Royce so another stock in the defence sector would unbalance my portfolio.
If it were not for this I would buy Chemring based on its earnings growth prospects and I think it is worth other investors considering.
