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Are Chemring Group plc, Ultra Electronics Holdings plc & Avon Rubber plc Top Picks For 2016?

The aerospace and defence sector continues to have strong relative appeal. That’s at least partly because many of the companies operating within the industry are true global players and are not highly dependent upon the UK economy for their sales and profitability. As such, they provide a significant amount of diversification potential which, in the long run, can smooth out portfolio returns.

Of course, not all companies within the sector are themselves stable. For example, defence company Chemring (LSE: CHG) is down by over 4% today and this takes its total fall for 2015 to 21%. The key reason for this is disappointing financial performance, with Chemring recently announcing a £90m rights issue (which is expected to take place in the first quarter of 2016) as it seeks to shore up its financial position.

Encouragingly, Chemring released a post-close update last week which stated that its expectations for the company’s trading performance for the year to the end of October 2015 remain in-line with previous expectations. However, no revenue from the 40mm ammunition contract to the Middle East has been recognised in the 2015 financial year, although export approvals have now been granted and revenues are expected to commence once the cash advance payment has been received.

Looking ahead, Chemring is expected to return to bottom line growth next year, with its earnings forecast to rise by 26%. This puts it on a price to earnings growth (PEG) ratio of just 0.5, which indicates that its shares offer good value for money. As such, and while further volatility is highly likely, Chemring could prove to be a sound long term buy.

Meanwhile, diversified software and electronics company Ultra Electronics (LSE: ULE) is expected to deliver a fall in its bottom line in the current financial year. Its earnings are due to fall by 1% following last year’s 3% decline as it finds trading tough and highly uncertain. In fact, it recently reported that the US Defence department’s budget has only recently been resolved and that, as such, 2015 has been a very difficult year.

Looking ahead, Ultra Electronics is due to meet its full-year expectations and, with significant cost-cutting on the horizon, is forecast to post a rise in its earnings of 8% next year. While positive, the market appears to have priced in a turnaround in profitability and, with Ultra Electronics trading on a price to earnings (P/E) ratio of 16.7, it may be prudent to wait for a keener share price before piling in.

Similarly, Avon Rubber (LSE: AVON) is due to report a fall in earnings per share of 2% in the current year and, with its shares trading on a P/E ratio of 19.5, they appear to be fully valued.

Of course, Avon Rubber has enjoyed a highly successful period, with its bottom line rising at an annualised rate of 21% during the last five years as strategic decisions to invest in innovative new products and technologies while expanding into international markets have begun to pay off. And, while the company’s long term prospects remain bright, it may be prudent to wait for a share price dip – especially since Avon Rubber’s shares have already risen by 39% this year. With them yielding just 0.9%, there appears to be a lack of major total return potential for 2016.

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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.