Chemring's struggles continue

US defence budget cuts continue to trouble Chemring (CHG), judging by a recent trading update. Revenue for the quarter ending 31 July fell from £111m to £77.5m. There were, however, some signs of stabilisation after what has been another difficult year for the British defence contractor.

For a start, the group’s order book was 4 per cent higher than at the start of the quarter, at £418m, with about a quarter of orders due for delivery in the current financial year to 31 October. Of particular note is the improving outlook for the company’s countermeasures business, which brought in a $22.2m (£13.6m) order in August from the US for infrared decoys.

Also positive was the news that Chemring’s net debt has almost halved to £117m. That was mainly thanks to the sale of its capital-intensive European munitions business in May. The £135m of proceeds it generated is being used to pay back loan notes. As a result, the company was able to refinance its revolving credit facility, now stretching to £70m for four years.

The group’s recently installed chief executive, Michael Flowers, noted "current world events and increasing NATO commitment". He speculated that this had the potential to stem the falls in defence spending seen in recent years.

Westhouse Securities says . . .

Sell. Chemring’s third quarter update blended the good – backlog, debt redemption – with the less good – revenue and a note of caution on 2014. We note the US continuing resolution to raise the Federal debt ceiling and related challenges for US defence spending, and believe low cash generation will be a key issue in coming years. For now, we do not expect US and Allied actions in the Middle East to move Chemring's figures materially. Having increased 14 per cent over three months, Chemring's stock is the most highly rated we cover. We cut our EPS forecasts for the financial years ending October 2014 and 2015 by 4 per cent to 12p and 13p respectively, and our price target to 130p.

Canaccord Genuity says . . .

Hold. There is little visibility on future orders, but increasing geopolitical tensions look set to provide positive momentum for Chemring. The company should benefit more from such tensions than most defence contractors, because it sells more short-cycle, conflict-related products. The largely restored balance sheet, lower interest costs and future rationalisation benefits in 2015 should also support earnings growth. We raise our target price to 225p (from 160p) and upgrade our view from 'sell' to 'hold'. We expect EPS to shrink 39 per cent this year to 9.5p, rising to 13.7p in fiscal 2015.