Most defence contractors have struggled to plug the gap left by US military budgets, but not Cohort (CHRT). The small defence systems and training company works mostly for the Ministry of Defence (MoD) where budgets have stabilised, and spending is shifting from tanks and guns to intelligence assets, submarines and combat aircraft - all areas where the company excels. But despite its strong prospects and a substantial cash pile, the shares trade at a sharp discount to the sector.
- Encouraging first quarter
- Substantial cash pile and property portfolio
- Significantly undervalued
- Earnings enhancing acquisitions likely
- Defence budgets tight
- Risk of contract delays
Despite Cohort's encouraging trading outlook, its diminutive size could arguably justify the fact that its PE ratio of 11.2 times, based on rolling next-twelve-months (NTM) consensus forecasts, represents a 15 per cent discount to the sector average. However, that's before the company's cash is taken into account. Broker Investec estimates that by the end of next April net cash should have risen to £19.1m - equivalent to more than a quarter of the current market capitalisation - before reaching £23.1m the following year. Based on the broker's forecasts and adjusting for interest earned on cash deposits, this implies a cash-adjusted NTM PE ratio for Cohort of just 8.1. That represents a near 40 per cent discount to its peers, which on average have net borrowings equivalent to 12 per cent of their market capitalisations.
With cash on deposit earning so little at the moment, it is perhaps understandable that the market has been paying little attention to this aspect of Cohort's business. However, acquisitions could bring the attractions of Cohorts strong balance sheet to the wider attention of the market. Cohort spoke to possible targets at last month’s arms fair in Docklands, but it won’t overpay and is under no pressure from major institutional shareholders, either. However, Investec "conservatively" estimates that acquisitions that used up the cash pile could boost earnings by between 15 and 20 per cent. That implies an eye-catching forward PE ratio of about 9 for the year to April 2015, which would make the current valuation anomaly stark.
COHORT (CHRT) | ||||
|---|---|---|---|---|
| ORD PRICE: | 181p | MARKET VALUE: | £74.2m | |
| TOUCH: | 180-182p | 12-MONTH HIGH: | 199p | LOW: 114p |
| FORWARD DIVIDEND YIELD: | 2.8% | FORWARD PE RATIO: | 11 | |
| NET ASSET VALUE: | 144p* | NET CASH: | £16.4m | |
| *Includes intangible assets of £31.5m, or 77p a share | ||||
| Year to 30 Apr | Turnover (£m) | Pre-tax profit (£m)** | Earnings per share (p)** | Dividend per share (p) |
|---|---|---|---|---|
| 2011 | 65.1 | 4.3 | 9.60 | 2.4 |
| 2012 | 75.4 | 6.5 | 15.5 | 2.9 |
| 2013 | 70.9 | 7.5 | 17.7 | 3.5 |
| 2014** | 73.6 | 7.8 | 15.9 | 4.2 |
| 2015** | 75.4 | 8.2 | 16.8 | 5.0 |
| % change | +2 | +5 | +6 | +19 |
Normal market size: 500 Matched bargain trading Beta: 0.3 **Investec Securities estimates, adjusted PTP and EPS figures | ||||
Even if Cohort does nothing, the underlying business is in good health. Working for government and defence primes like BAE Systems, Thales and Raytheon means Cohort has no bad debts. And management reckons UK defence cuts are over, which is a relief, given the MoD generated almost three-quarters of sales last year. Roughly a third of the MoD’s £35bn annual budget is earmarked for procurement, and Cohort is well-placed.
The group has recently announced a number of wins such as £4.1m to demonstrate the airworthiness of F-35 Joint Strike Fighters and £11m for external communications gear bound for the latest Astute-class nuclear-powered submarines. There are also inroads being made into non-defence markets such as traffic monitoring and secure IT systems for schools. All this helped the order book grow by £6m in the first quarter to £102m.
