Ultra Electronics
Written by
Ultra Electronics |
Strategically positioned for growth |
H1 results |
Aerospace & defence |
4 August 2016 |
Share price performance
Business description
Next events
Analysts
Ultra Electronics is a research client of Edison Investment Research Limited |
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Ultra’s interim results showed solid progression, boosted by FX and initial first half contributions from last year’s acquisitions. Earnings appear set to start growing again, although management retains a healthy element of caution with respect to market expectations of improving defence spending trends in the western world. Investment for growth has remained at a high level. The resultant increase in new products and contracts should start to drive improved organic growth from 2017 and support our fair value, which currently stands at 1,975p.
Year |
Revenue (£m) |
PBT* |
EPS* |
DPS |
P/E |
Yield |
12/14 |
713.7 |
112.0 |
123.1 |
44.3 |
13.8 |
2.6 |
12/15 |
726.3 |
112.4 |
123.9 |
46.1 |
13.7 |
2.7 |
12/16e |
797.3 |
117.1 |
128.3 |
47.6 |
13.3 |
2.8 |
12/17e |
821.4 |
121.8 |
133.5 |
49.5 |
12.7 |
2.9 |
Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.
Flat defence markets offset by FX and M&A
H116 organic sales growth was -2.5%, adversely affected by the winding down of the ECU RP contract in the UK. The 2015 acquisitions made healthy contributions and the favourable move in $/£ towards the period end improved translation of US sales and profits (54% of H1 sales). Defence spending was healthy in Q1 but tailed off in Q2, particularly in the US. Prospects for a global uplift remain positive at present from 2017. Order intake improved, with 40% of 2015’s deferred orders captured during the period and good prospects for much of the remainder to be recovered soon. Cash conversion of 67% was a marked improvement on the prior year, and the £30m increase in net debt was largely the result of FX (-£21m).
Modest upgrade to revenues and profits
We have adjusted our forecasts for the expected sale of Ultra ID Systems, which has yet to complete, as well as the sharp fall in sterling, which boosts translation of US sales and profits. ID reduces sales by around £20m a year and profits by £4m, while an average $1.38/£ FX rate for FY16 adds around £45m to sales and £3m to operating profit. Management continues to guide for flat organic sales growth, having tightened the expected range to ±1%, boosted by the additional contributions of Furnace Parts and Herley, which should add around 5% to sales. Order cover for the year stood at 84% at the half year and improved further in July, allowing management to remain confident. FY17 should see improved organic growth picking up, as well as a likely, smaller FX benefit.
Valuation: Yet to fully reflect growth in defence
Our 2017 peer-based sum of the parts (SOP) has benefited from the continued positive performance of defence stocks in an uncertain market. In addition, prospects appear to be undiminished for defence spending despite Brexit, although this could be at least partially compromised by lower economic growth. Our peer-based SOP returns 1,979p currently and our capped DCF 1,971p an average of 1,975p.
H116 results
Order book, intake and prospects
Ultra’s order book stood at £785.7m at the end of H1, up 3.1% from the start of the year. However, this includes only firm orders not options, IDIQs or platform agreements, which are deemed to be “off order book”. However, the off order book business pipeline has expanded to around £2.4bn from £1.5bn previously, and many civil aircraft programmes are just at the start of a significant production ramp-up. Order cover improved to 87% for the year after strong order intake in July. It is these factors that led management to tighten the organic revenue growth target to ±1%.
Revenues and profits
Revenues in H1 grew £34.9m to £366.4m, with an organic decline of £8.2m (-2%) more than offset by translation gains, which added £10.6m, and acquisitions (+£32.5m). The £7.3m increase in adjusted operating profit to £57.7m benefited from £1m of FX translation, £4.3m from acquisitions and a £0.9m organic decline. There was also a somewhat exceptional benefit of £2.9m arising from the FX impact on US$ working capital held in the UK against contracts.
The S3 programme remains on track and some £7m should be spent by the end of 2016, with savings largely covering the below-the-line costs. There is significant work ongoing to identify additional process improvements and shared services benefits without compromising the agility and innovation Ultra has traditionally displayed as a Tier III/Tier IV supplier. Ultra continues to invest heavily to support future growth, with some £73.9m (H115 £75.1m) spent during the period on R&D (including customer-funded) and acquisitions.
With 54% of group sales in the US following the Herley acquisition, much of it of local origin, the translation of US profits should continue to benefit from sterling weakness. While this is largely a quantum not quality issue as far as earnings are concerned, it nevertheless increases the absolute amount of earnings. Every 1 cent improvement against sterling adds some £3m to sales and £0.4m to operating profit. Hence an average of $1.38/£ expectation versus $1.53/£ in 2015 is a major boost to earnings, with a more modest benefit likely in 2017 with the spot rate currently €1.32/£.
We have updated our estimates to reflect two factors: the dilutive disposal of ID and the benefit of the sharp fall in sterling. Our assumption of flat organic growth this year and a 5% additional contribution from FY15 acquisitions remains in line with tightened management guidance.
Exhibit 1: Ultra Electronics earnings revisions
Sales (£m) |
PBT (£m) |
EPS (p) |
|||||||
Old |
New |
% chg. |
Old |
New |
% chg. |
Old |
New |
% chg. |
|
2016e |
781.8 |
797.3 |
+2.0 |
116.6 |
117.1 |
+0.5 |
127.7 |
128.3 |
+0.5 |
2017e |
807.2 |
821.4 |
+1.8 |
122.4 |
121.8 |
-0.4 |
134.0 |
133.5 |
-0.4 |
Source: Edison Investment Research estimates. Note: FY17 estimated old EPS restated to correct calculation basis.
Valuation: Growth potential not yet reflected
Our fair value calculation based on an average of our capped DCF methodology and a FY17 peer group SOP currently stands at 1,975p, significantly ahead of the current share price. There are potential risks to both the upside and downside in defence. The perceived wisdom is that both threats and thus global defence spending will increase. However, new political leadership could alter the dynamics on overall allocations and priorities within budgets. Brexit does not pose a significant direct threat, although the impact of lower growth may curtail budgets to a degree.
Exhibit 2: Financial summary
£m |
2014 |
2015 |
2016e |
2017e |
|
Year end 31 December |
IFRS |
IFRS |
IFRS |
IFRS |
|
PROFIT & LOSS |
|||||
Revenue |
|
713.7 |
726.3 |
797.3 |
821.4 |
Cost of Sales |
(494.3) |
(514.1) |
(580.9) |
(609.9) |
|
Gross Profit |
219.4 |
212.2 |
216.4 |
211.4 |
|
EBITDA |
|
128.9 |
130.9 |
142.5 |
146.5 |
Operating Profit (before amort. and except.) |
|
118.1 |
120.0 |
130.7 |
134.6 |
Intangible Amortisation |
(3.4) |
(3.8) |
(3.7) |
(3.6) |
|
Exceptionals |
(97.8) |
(81.7) |
(58.3) |
(44.0) |
|
Other |
0.0 |
0.0 |
0.0 |
0.0 |
|
Operating Profit |
16.8 |
34.5 |
68.7 |
86.9 |
|
Net Interest |
(6.0) |
(7.5) |
(13.6) |
(12.8) |
|
Profit Before Tax (norm) |
|
112.0 |
112.4 |
117.1 |
121.8 |
Profit Before Tax (FRS 3) |
|
10.8 |
27.0 |
55.1 |
74.1 |
Tax |
(15.0) |
(9.8) |
(16.9) |
(17.9) |
|
Profit After Tax (norm) |
86.0 |
86.8 |
90.2 |
93.8 |
|
Profit After Tax (FRS 3) |
(4.2) |
17.2 |
38.2 |
56.3 |
|
Average Number of Shares Outstanding (m) |
69.9 |
70.1 |
70.3 |
70.3 |
|
EPS - normalised (p) |
|
123.1 |
123.9 |
128.3 |
133.5 |
EPS - normalised and fully diluted (p) |
|
122.8 |
123.8 |
128.1 |
133.3 |
EPS - (IFRS) (p) |
|
14.5 |
24.5 |
54.4 |
80.0 |
Dividend per share (p) |
44.3 |
46.1 |
47.6 |
49.5 |
|
Gross Margin (%) |
30.7 |
29.2 |
27.1 |
25.7 |
|
EBITDA Margin (%) |
18.1 |
18.0 |
17.9 |
17.8 |
|
Operating Margin (before GW and except.) (%) |
16.5 |
16.5 |
16.4 |
16.4 |
|
BALANCE SHEET |
|||||
Fixed Assets |
|
532.1 |
639.1 |
594.5 |
566.8 |
Intangible Assets |
461.5 |
570.9 |
524.8 |
492.7 |
|
Tangible Assets |
62.6 |
68.2 |
69.6 |
74.2 |
|
Investments |
8.1 |
0.0 |
0.0 |
0.0 |
|
Current Assets |
|
250.6 |
308.5 |
342.1 |
352.3 |
Stocks |
73.7 |
81.8 |
91.7 |
97.3 |
|
Debtors |
101.5 |
117.0 |
139.5 |
142.8 |
|
Cash |
41.3 |
45.5 |
45.5 |
45.5 |
|
Other |
34.1 |
64.2 |
65.5 |
66.8 |
|
Current Liabilities |
|
(199.8) |
(181.4) |
(183.3) |
(188.1) |
Creditors |
(199.8) |
(181.4) |
(183.3) |
(188.1) |
|
Short term borrowings |
0.0 |
0.0 |
0.0 |
0.0 |
|
Long Term Liabilities |
|
(279.6) |
(447.5) |
(441.4) |
(394.0) |
Long term borrowings |
(170.8) |
(341.0) |
(347.6) |
(299.8) |
|
Other long term liabilities |
(108.8) |
(106.5) |
(93.8) |
(94.2) |
|
Net Assets |
|
303.4 |
318.7 |
311.9 |
337.0 |
CASH FLOW |
|||||
Operating Cash Flow |
|
97.8 |
85.4 |
85.6 |
131.1 |
Net Interest |
(4.5) |
(6.0) |
(7.5) |
(13.6) |
|
Tax |
(22.9) |
(26.0) |
(17.3) |
(17.9) |
|
Capex |
(17.7) |
(6.4) |
(21.7) |
(18.2) |
|
Acquisitions/disposals |
(104.5) |
(171.8) |
22.0 |
0.0 |
|
Financing |
2.2 |
4.9 |
0.0 |
0.0 |
|
Dividends |
(29.7) |
(31.3) |
(32.6) |
(33.7) |
|
Other |
(5.6) |
(13.9) |
(35.1) |
0.0 |
|
Net Cash Flow |
(84.9) |
(165.2) |
(6.6) |
47.8 |
|
Opening net debt/(cash) |
|
42.2 |
129.5 |
295.6 |
302.2 |
HP finance leases initiated |
0.0 |
0.0 |
0.0 |
0.0 |
|
Other |
(2.5) |
(0.9) |
0.0 |
0.0 |
|
Closing net debt/(cash) |
|
129.5 |
295.6 |
302.2 |
254.4 |
Source: Company reports, Edison Investment Research
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