Ultra Electronics has more than delivered on our earnings expectations in FY16, with anticipated flat organic performance boosted by M&A and FX in the second half. The outlook is for slightly improved organic growth in FY17 marginally offset by dilution from the ID disposal. With net debt down significantly we would also expect increased M&A to augment the improving defence spending environment, which should accelerate in FY18. Having rolled the base forward a year, our fair value for now stands at 2,257p.
Written by
Ultra Electronics |
Strengthening defence |
FY16 results |
Aerospace & defence |
6 March 2017 |
Share price performance
Business description
Next events
Analysts
Ultra Electronics is a research client of Edison Investment Research Limited |
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Ultra Electronics has more than delivered on our earnings expectations in FY16, with anticipated flat organic performance boosted by M&A and FX in the second half. The outlook is for slightly improved organic growth in FY17 marginally offset by dilution from the ID disposal. With net debt down significantly we would also expect increased M&A to augment the improving defence spending environment, which should accelerate in FY18. Having rolled the base forward a year, our fair value for now stands at 2,257p.
Year end |
Revenue (£m) |
PBT* |
EPS* |
DPS |
P/E |
Yield |
12/15 |
726.3 |
112.4 |
123.9 |
46.1 |
16.0 |
2.3 |
12/16 |
785.8 |
120.1 |
134.6 |
47.8 |
14.7 |
2.4 |
12/17e |
812.8 |
121.4 |
134.7 |
49.5 |
14.7 |
2.5 |
12/18e |
852.8 |
130.2 |
144.5 |
52.0 |
13.7 |
2.6 |
Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.
Continuing to execute as expected
In what was a more normal year in 2016, in stark contrast to some of its UK defence peers, Ultra’s performance exceeded our expectations at the earning level. Sales did fail to meet the flat organic growth guidance due to delays on the award of a few export contracts, which deferred revenue recognition. Nevertheless, a broadly flat organic performance was diluted by the disposal of ID after eight months. The upside came from the better than expected integration of Herley, which achieved synergies ahead of its business case by $1.5m, as well as more favourable FX. The balance of the performance came from strong execution across the group, notably as deliveries on some major sonobuoy contracts concluded in Maritime & Land.
Balance sheet supports strategy
The company delivered better than expected operating cash flow in FY16, achieving cash conversion of 92%, the best since 2011. Ultra continues to invest for growth with £34.1m (4.3% of sales) spent on new capabilities, £5m on M&A and substantial customer funding. Proceeds of £22m from disposals helped to reduce the year end net debt to £256.7m, despite adverse FX. The cash flow also supported a dividend increase of 3.7%, slightly ahead of our expectations, but with an increased level of earnings cover.
Valuation: Accelerating growth in 2018
We have rolled our sum of the parts and DCF based valuation forward by one year. We calculate our estimated fair value based on a simple average of these two measures, which currently returns a value of 2,257p (previously 2,037p). The shares have performed well since our Outlook note in September, and are further supported by the prospect of accelerating global defence spending in 2018.
FY16 results boosted by FX
The results for 2016 have been delivered slightly ahead of expectations at the profit levels. The more promising outlook for defence spending has gained momentum in recent months and provides a supportive framework for prospects. Commercial aerospace prospects are also good with a number of contracts expected to transition into production in 2017. In addition, Ultra continues to invest for growth, with over 19% of sales spent in 2016 on pursuing both organic and M&A opportunities, including customer funding.
In fact the order book rose 6% to £799.3m following a stronger year of order intake of £778.3m, up 22% on the prior year. On an underlying basis allowing for FX and acquisitions, the order intake was up 10.4%. Order cover for 2017 is said to be at usual levels.
Sales rose by 8.2% to £785.8m (FY15 £726.3m). Organic sales growth of -4.1% was slightly below guidance; this is attributed to delays in signing some export contracts, including the India torpedo defence contract. The completion of the End Cryptographic Unit Replacement Programme (ECU RP) also weighed on sales. FX contributed 7.5% to sales growth and full year contributions from 2015 acquisitions, predominantly Herley and Furnace Parts, added 5.8%. Disposals diluted the performance by 1%.
Underlying operating profit improved 9.3% with a strong bounce back from Maritime & Land, and good growth in Aerospace & Infrastructure more than compensating for a flat performance in Communications & Security, which was affected by the disposal of ID as well as the ECU RP contract. As FX and acquisitions contributed 10.6% to the overall improvement, the organic improvement was only 0.2% allowing for the ID disposal dilution of 1.5%.
The S3 shared service programme remains on track, with the UK Global Business Service (GBS) centre in operation, and a second planned for the US. Ultra charged £6.5m against the programme in 2016, up from £4.9m in 2015. The programme remains a key part of driving internal efficiencies.
Having benefited from the anticipated ID disposal proceeds, year end net debt stood at £256.7m. This was nevertheless lower than both the market and our own expectations by some distance, representing a much better operational performance.
Defence spending growth resumes
Ultra expects global defence spending to rise by around 3% in 2017, arresting several years of decline. We would expect this to accelerate further in 2018 given the pressures to increase spending in Europe combined with the increased defence budget the Trump administration is proposing in the US. Spending always lags budgets by 18 months to two years, and a Continuing Resolution (CR) remains in place in the US for the time being, deferring spending towards H217. Assuming a coordinated Republican approach in Congress even a CR might be avoided next year, and the threat of sequestration might be lifted.
The general macro picture remains more uncertain, with changes likely in the way the world does business following the changes in the US and the decision in the UK to leave the EU. With only 7% of sales generated by exports from the UK to Europe, Brexit should not be major concern for Ultra.
In Aerospace (17% of group sales), commercial aircraft programme ramp ups are gaining pace, placing pressure on the supply chain to perform but supported by continued growth in air travel. Military aircraft prospects for Ultra remain dominated by the F-35, where increased production rates continue. Communications (15% of sales) market growth is expected to be maintained at a healthy rate, with military communications expected to grow 7% per annum, and the prognosis for C2ISR (21% of sales) markets also remains very positive, driven by geopolitical tensions. With improving prospects for both the Underwater Warfare and Maritime segments, which represent 32% of sales, the overall picture for Ultra looks encouraging.
Exhibit 1: Ultra Electronics summary financial estimates revisions
Year to December (£m)
|
2016e |
2016 |
% change |
2017e |
2017e |
% change |
Prior |
Actual |
Prior |
New |
|||
Aerospace & Infrastructure |
219.1 |
204.7 |
-6.6% |
230.0 |
212.9 |
-7.5% |
Maritime & Land |
310.5 |
322.1 |
3.7% |
319.8 |
331.9 |
3.8% |
Communications & Security |
267.7 |
259.0 |
-3.2% |
271.5 |
268.0 |
-1.3% |
Sales |
797.3 |
785.8 |
-1.4% |
821.4 |
812.8 |
-1.1% |
|
|
|
|
|
|
|
EBITDA |
146.0 |
148.0 |
1.4% |
150.0 |
149.8 |
-0.1% |
|
|
|
|
|
|
|
Aerospace & Infrastructure |
33.5 |
32.4 |
-3.4% |
35.2 |
33.0 |
-6.2% |
Maritime & Land |
54.3 |
59.1 |
8.7% |
56.0 |
58.4 |
4.4% |
Communications & Security |
42.8 |
39.7 |
-7.3% |
43.4 |
41.5 |
-4.4% |
Underlying EBITA |
130.7 |
131.1 |
0.3% |
134.6 |
132.9 |
-1.2% |
|
|
|
|
|
|
|
Underlying PBT |
117.1 |
120.1 |
2.5% |
121.8 |
121.4 |
-0.3% |
|
|
|
|
|
|
|
EPS – underlying continuing (p) |
128.3 |
134.6 |
5.0% |
133.5 |
134.7 |
0.9% |
DPS (p) |
47.6 |
47.8 |
0.4% |
49.5 |
49.5 |
0.0% |
Net debt/(cash) |
284.2 |
256.7 |
-9.7% |
236.5 |
228.5 |
-3.4% |
Source: Ultra Electronics reports, Edison Investment Research estimates
We have modestly reduced our sales expectations for the current year, although we expect a marginal improvement in pre-tax profit and EPS in FY17.
Valuation
We have moved our sum of the parts valuation to an FY18 basis, and rolled our DCF forward following the year end. Our capped DCF currently returns a value of 2,061p (2,026p previously). The optimism in defence markets has continued to drive defence ratings higher in recent months and we have rolled our sum-of-the-parts (SOTP) methodology forward to a 2018 basis. Our previous basis returned a value of 2,048p, and the shares have been approaching that level. Our FY18 SOTP-based fair value is 2,452p, as shown in Exhibit 2 below. The improvement reflects the acceleration of profitability expected next year aided by a lower tax charge, as well as a sharp re-rating of the communications peers as defence growth prospects have improved. We calculate our estimated fair value of the company based on a simple average of these two measures, which currently returns a value of 2,257p (previously 2,037p)
Exhibit 2: Edison sum-of-the-parts valuation (FY18 basis)
|
2018e EBITA (£m) |
Tax rate (%) |
2018e NOPAT (£m) |
P/E |
Value (£m) |
Basis |
Aerospace & Infrastructure |
34.9 |
22.0 |
27.2 |
17.4 |
473 |
US peers (Raytheon, Rockwell Collins) + premium to Thales & BAE – Civil Aviation |
Maritime & Land |
60.7 |
22.0 |
47.4 |
16.9 |
801 |
20% premium to UK sector (15.5x) – Pivot to Pacific opportunity |
Communications & Security |
44.6 |
22.0 |
34.8 |
20.3 |
706 |
Premium rating to US peers (Rockwell Collins, L-3 Communications), enhanced commercial exposure |
Enterprise value |
1,980 |
|||||
Net cash/(debt) |
(257) |
December 2016 net debt |
||||
Equity value |
1,723 |
|||||
Shares in issue (m) |
70 |
|||||
Implied fair value per share (p) |
|
|
|
|
2,452 |
|
Source: Bloomberg and Edison Investment Research estimates
Exhibit 3: Financial summary
£m |
2014 |
2015 |
2016 |
2017e |
2018e |
||
Year end 31 December |
IFRS |
IFRS |
IFRS |
IFRS |
IFRS |
||
PROFIT & LOSS |
|||||||
Revenue |
|
|
713.7 |
726.3 |
785.8 |
812.8 |
852.8 |
Cost of Sales |
(494.3) |
(514.1) |
(580.9) |
(609.9) |
(640.4) |
||
Gross Profit |
219.4 |
212.2 |
204.9 |
202.8 |
212.3 |
||
EBITDA |
|
|
132.3 |
134.8 |
148.0 |
149.8 |
157.2 |
Operating Profit (before amort. and except.) |
|
|
118.1 |
120.0 |
131.1 |
132.9 |
140.2 |
Intangible Amortisation |
(3.4) |
(3.8) |
(5.4) |
(5.1) |
(4.9) |
||
Exceptionals |
(97.8) |
(81.7) |
(71.5) |
(44.4) |
(39.0) |
||
Other |
0.0 |
0.0 |
0.0 |
0.0 |
0.0 |
||
Operating Profit |
16.8 |
34.5 |
54.2 |
83.5 |
96.4 |
||
Net Interest |
(6.0) |
(7.5) |
(11.1) |
(11.5) |
(10.0) |
||
Profit Before Tax (norm) |
|
|
112.0 |
112.4 |
120.1 |
121.4 |
130.2 |
Profit Before Tax (FRS 3) |
|
|
10.8 |
27.0 |
43.1 |
71.9 |
86.3 |
Tax |
(15.0) |
(9.8) |
(9.4) |
(17.0) |
(20.1) |
||
Profit After Tax (norm) |
86.0 |
86.8 |
94.7 |
94.7 |
101.6 |
||
Profit After Tax (FRS 3) |
(4.2) |
17.2 |
33.8 |
55.0 |
66.3 |
||
Average Number of Shares Outstanding (m) |
69.9 |
70.1 |
70.3 |
70.3 |
70.3 |
||
EPS - normalised (p) |
|
|
123.1 |
123.9 |
134.6 |
134.7 |
144.5 |
EPS - normalised and fully diluted (p) |
|
|
122.8 |
123.8 |
134.5 |
134.6 |
144.3 |
EPS - (IFRS) (p) |
|
|
14.5 |
24.5 |
48.0 |
78.2 |
94.3 |
Dividend per share (p) |
44.3 |
46.1 |
47.8 |
49.5 |
52.0 |
||
Gross Margin (%) |
30.7 |
29.2 |
26.1 |
25.0 |
24.9 |
||
EBITDA Margin (%) |
18.5 |
18.6 |
18.8 |
18.4 |
18.4 |
||
Operating Margin (before GW and except.) (%) |
16.5 |
16.5 |
16.7 |
16.4 |
16.4 |
||
BALANCE SHEET |
|||||||
Fixed Assets |
|
|
532.1 |
637.2 |
655.4 |
626.5 |
601.7 |
Intangible Assets |
461.5 |
569.0 |
589.2 |
555.8 |
526.1 |
||
Tangible Assets |
62.6 |
68.2 |
66.2 |
70.7 |
75.6 |
||
Investments |
8.1 |
0.0 |
0.0 |
0.0 |
0.0 |
||
Current Assets |
|
|
250.6 |
308.5 |
364.9 |
392.3 |
407.9 |
Stocks |
73.7 |
81.8 |
78.2 |
83.3 |
90.0 |
||
Debtors |
101.5 |
117.0 |
142.5 |
162.6 |
169.7 |
||
Cash |
41.3 |
45.5 |
74.6 |
74.6 |
74.6 |
||
Other |
34.1 |
64.2 |
69.6 |
71.9 |
73.5 |
||
Current Liabilities |
|
|
(199.8) |
(181.4) |
(178.6) |
(178.3) |
(186.4) |
Creditors |
(199.8) |
(181.4) |
(178.6) |
(178.3) |
(186.4) |
||
Short term borrowings |
0.0 |
0.0 |
0.0 |
0.0 |
0.0 |
||
Long Term Liabilities |
|
|
(279.6) |
(447.5) |
(478.1) |
(451.7) |
(399.7) |
Long term borrowings |
(170.8) |
(341.0) |
(331.3) |
(303.1) |
(249.3) |
||
Other long term liabilities |
(108.8) |
(106.5) |
(146.8) |
(148.6) |
(150.5) |
||
Net Assets |
|
|
303.4 |
316.8 |
363.6 |
388.9 |
423.5 |
CASH FLOW |
|||||||
Operating Cash Flow |
|
|
97.8 |
85.4 |
117.8 |
109.0 |
140.6 |
Net Interest |
(4.5) |
(6.0) |
(7.5) |
(11.1) |
(11.5) |
||
Tax |
(22.9) |
(26.0) |
(17.3) |
(17.0) |
(20.1) |
||
Capex |
(17.7) |
(6.4) |
(7.4) |
(19.0) |
(19.8) |
||
Acquisitions/disposals |
(104.5) |
(171.8) |
16.8 |
0.0 |
0.0 |
||
Financing |
2.2 |
4.9 |
3.0 |
0.0 |
0.0 |
||
Dividends |
(29.7) |
(31.3) |
(32.6) |
(33.8) |
(35.3) |
||
Other |
(5.6) |
(13.9) |
(34.0) |
0.0 |
0.0 |
||
Net Cash Flow |
(84.9) |
(165.2) |
38.9 |
28.2 |
53.9 |
||
Opening net debt/(cash) |
|
|
42.2 |
129.5 |
295.6 |
256.7 |
228.5 |
HP finance leases initiated |
0.0 |
0.0 |
0.0 |
0.0 |
0.0 |
||
Other |
(2.5) |
(0.9) |
0.0 |
0.0 |
(0.0) |
||
Closing net debt/(cash) |
|
|
129.5 |
295.6 |
256.7 |
228.5 |
174.6 |
Source: Ultra Electronics report, Edison Investment Research estimates
|
|
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