Setbacks are part of life. Every listed company knows it must expect the occasional bruising experience. What matters is having the financial resilience to cushion the blow and to learn from the episode.
Companies derive their revenues from high-value, long-term contracts and orders are especially vulnerable. Mistakes at this level will be of a different magnitude and can turn profits into losses while vexed shareholders drive the share price down. But setbacks are survivable. The evidence of this, and indeed the regularity of problems occurring, can be seen in the defence and engineering sectors.
Soaring labour and materials costs have for example created a £190mn headache for Babcock International as it completes an order for Type 31 frigates for the Ministry of Defence, commissioned in 2019 on a fixed price contract.
Defence contractor Qinetiq encountered its own difficult contractual situation a few years ago. That led to £14.5mn of writedowns for the company. It took it on the chin and moved on.
Engineer Rolls-Royce took a £1bn hit when reliability issues with its Trent engines emerged in 2016. Just as the company fixed those problems and pulled itself out of that tight spot, it felt the full force of the pandemic as planes were grounded. If you’d given up on the company at that point, however, you’d have missed out on its share price rising from 39p to well over 500p. Babcock has also bounced back and is supported by the volatile geopolitical backdrop, which means its services remain in demand.
BUY: Qinetiq (QQ.)
The result of the UK’s strategic defence review is a risk factor to keep an eye on, writes Christopher Akers.
Defence technology specialist Qinetiq reiterated annual guidance and raised its share buyback programme from £100mn to £150mn, after its half-year results benefited from what chief executive Steve Wadey referred to as “a backdrop of political change and an evolving threat environment”.
Revenue growth in the period was driven by a 10 per cent uplift at the company’s higher-margin Emea (Europe, Middle East and Australasia) services division, which was underpinned by progress in the UK market. The domestic market, across defence and intelligence services, delivered 88 per cent of divisional revenue. The unit enjoyed a 16 per cent bump in orders, helped by a €284mn (£236mn) decade-long threat representation and training services programme with the German armed forces.
Something to watch here is the outcome of the UK government’s strategic defence review, which is expected to report in the first half of next year. Labour has pledged to increase defence spending to 2.5 per cent of GDP, from the current position of around 2.3 per cent, albeit only over time.
Agency Partners analysts warned ahead of the results that the review, “combined with general UK government spending pressures, appears to be slowing the pace and scope of new orders”.
Meanwhile, revenue at the smaller global solutions division came in flat against a tough comparative. Avantus, the data, cyber and space services and solutions business the company acquired for €590mn in 2022, is trading in line with management’s expectations.
Underlying operating profit rose 6 per cent to £107mn, while the margin stayed flat at 11.3 per cent.
Total orders were up 9 per cent to £1.03bn on the strength of Emea services, with a book-to-bill ratio of 1.3 times. The order backlog sits at £2.9bn, down from £3.1bn last year.
The strong balance sheet provides the firepower for further investment, with net debt falling from £274mn to £191mn year on year. Capex was £48.6mn in the period and management expects £90mn-£120mn across the full year. The buyback move looks reasonable given the manageable leverage ratio of 0.6 times.
Annual guidance is still for high single-digit organic revenue growth and a stable operating margin. The board flagged that the company is on track to deliver organic revenue of £2.4bn and a margin of 12 per cent by 2027.
Qinetiq trades on 14 times forward consensus earnings, a rating in line with the five-year average. This looks undemanding, as the company appears to focus its sights more on the return of capital than on further M&A.
BUY: Young & Co’s Brewery (YNGA)
Brewer has realised £6mn of savings by combining head offices and IT systems, writes Michael Fahy.
The significant step-up in revenue at Young & Co’s Brewery following its £158mn purchase of City Pub Group in March hasn’t yet been matched by a commensurate bump in margins, but chief executive Simon Dodd seems confident that it will.
The deal added 50 pubs to Young’s estate, bringing the total to 279. It is the biggest acquisition Young’s has ever completed, so the “minor negative effect” on margins was expected, Dodd said.
Young’s has, however, already delivered £6.1mn of savings it had targeted by combining head offices and IT systems and it expects the benefit from new beer supply deals signed in September to filter through in the current half.
Unsurprisingly, net debt more than doubled year on year to £256mn, although this figure has come down from £268mn at its March year-end thanks in part to the sale of six pubs. Operating cash flow of £46.1mn also helped, although it funnelled £22mn back into pub upgrades.
Young’s shares have performed poorly this year and the company is facing cost pressures — Dodd says the increases in employers’ NI contributions and the minimum wage will add around £11mn to its costs from next April. However, by then analysts expect a more meaningful contribution to profits from the City Pub deal.
Earnings per share are expected to be largely flat next March but to grow by 7 per cent over the following two years. The company’s enterprise value of seven times cash profit is in line with peers, but well below pre-Covid levels of 12 times, said Panmure Liberum analyst Anna Barnfather. She thinks the quality of Young’s pubs and “operational excellence” deserve more of a premium. We concur.
HOLD: Avon Technologies (AVON)
Avon Technologies has upgraded its performance, writes Julian Hofmann.
Having started the decade as a company that included rubber milking teats in its product portfolio, there was ample evidence in these preliminary results that the sometimes-painful move into defence and security products is starting to pay off for Avon Technologies, as a mix of higher defence spending and operational efficiency restored profitability and led to market upgrades.
Management explained how operational improvements have helped the company. Chief financial officer Rich Cashin said: “We have always had a big September for orders, with people rushing to push things through.” The overall order book was $225mn, or 64 per cent higher.
“However, with our improvements the receivables are now more balanced across the year.” The results showed receivables of $36.9mn (£29mn), compared with $58.3mn, in 2023. “This meant our 12 per cent revenue growth was done without really increasing inventory,” Cashin said.
This operational improvement also showed up in better cash performance, as cash flows from operations surged to $63.7mn, with less cash tied up in warehousing goods. Overall, along with better operating profits, the return on invested capital was 13.7 per cent. Management said that forecasts for a mid-teens return on capital for 2026 was now a year ahead of schedule.
Broker Peel Hunt said 2026 now looks like the key “earnings inflection point” for Avon and the shares currently trade at 15 times that year’s earnings.
In the near term, the share price is closer to a price/earnings (PE) ratio of 23.4, which is roughly in line with the peer group after a rapid recovery. While attractive, it may be worth waiting to see how quickly the dividend grows before getting involved.
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