Cheap Chemring ready to recover

In fact, a counter attack is already underway. In late November, just days after Chemring’s share price sunk to a seven-year low, chief executive Mark Papworth shot down talk of a possible rights issue - the company remains on good terms with debt holders, he says - and repeated guidance for full-year results. Admittedly, expectations had been revised sharply lower only six weeks earlier - the US government shutdown, production issues and strong dollar cost about £8m of operating profit - but conditions are, at least, no worse, and problems are being resolved.

Much of the fallout from warring Congressmen has been cleared up, says Mr Papworth, and issues with production at Kilgore, Chemring’s accident-prone decoy flares factory in Tennessee, are being worked through. Further management changes have been made there, too. What’s more, and despite the impact on cash receipts caused by hold-ups shipping to the Middle East, net debt fell by £45m in the fourth quarter, more than expected. A £14m cheque received since should keep annual borrowing on a downward trend, underpinned by a sharp drop in capital spending, down two-thirds during the first half of last year.

And it’s the prospect of a cash windfall that could keep Chemring’s share price yomping higher still. Having spent the past year bedding in, Mr Papworth and new finance boss Steve Bowers have completed much of the strategic planning and are finally putting their master plan to work. Yes, they’ve identified further cost savings, and a number of defence and non-defence opportunities not yet fully exploited. Aggressive targets have been set for management, too. But, like rival Qinetiq, currently hawking its US services division, it is the decision to begin offloading unwanted businesses that is the really exciting bit.

For now, all we are told is that "a number" of Chemring’s business units "do not form part of its longer-term strategy," and that management has kick-started the process to sell them. Few analysts are prepared to speculate which ones, but Citi admits it would cheer the sale of the lower-margin munitions operation, and Investec Securities reckons external buyers would value businesses dumped in Chemring’s Energetic Sub-Systems division.

Management will likely use full-year results on 23 January to flesh out the detail, but as JP Morgan rightly points out, current uncertainty provides "the opportunity for a surprise on the proceeds." Remember, too, that US private equity giant Carlyle considered buying Chemring in 2012, and despite walking away after three months of talks, it definitely saw something of interest. Back then, analysts told us they thought someone like Germany’s Rheinmetall, or former Honeywell unit ATK would eventually buy Chemring. They still might.

Clearly, Chemring will want to hang on to the sensors division, where margins are far higher than the other three units and opportunities to break into new markets are greater. Its countermeasures operation will remain core, too. Here, volumes have likely bottomed out and should recover when both the F-35 and Typhoon jets go fully operational.

Of course, defence spending among NATO customers remains tight, and non-NATO clients have deferred orders. Indeed, having slumped by a quarter in the final three months of the financial year to £185m, revenue fell 16 per cent to about £625m last year. An order book worth £702m is down 8 per cent, too. This year, however, might be better than feared following an agreement struck in Congress last month. Cuts to military spending in the US, where Chemring generates just under half its sales, will be reduced by $31.5bn (£19.2bn) over the next two years - valuable time to diversify into civilian markets.