Chemring ready to recover

Chemring's latest share price fall was triggered by an £81m rights issue and temporary axing of the dividend. But now that the smoke is clearing, a number of positives are emerging from recent events, including the favourable effect this funding will have on the balance sheet, which will allow Chemring to pursue growth prospects.

Most of the £75m net proceeds from the rights issue will be used to service debt, which has been so crippling in recent years that it forced the group to halt the restructuring plans necessary to grow the business. Now that management is closing in on its target to halve the net debt to cash profit ratio to a range of one to 1.5 times, action to consolidate sites, automate manufacturing and upgrade the product range can finally be taken.

Coinciding with the resolution of this long-term issue is an improved outlook in key end markets. Against a backdrop of growing global geopolitical tensions, Chemring's main customer, the US Department of Defence, recently signalled an end to years of austerity by raising its spending caps. The latest budget deal brings the Pentagon's kitty up to $585bn (£399bn) in 2016, from £560bn the previous fiscal year, and upwards thereafter.

As Chemring's market-leading countermeasures, chemical and biological detection and ground penetrating radar products have already been shortlisted for use by the North American government, the defence contractor looks odds on to be a big beneficiary of this uptick in spending. But while this is great for prospects, there's a caveat - money from inflated budgets in the 2016 fiscal year won't be spent until 2017 at the earliest.

Fortunately, there are signs to suggest that orders from elsewhere can help to fill this gap. That includes the long-awaited arrival of a large Middle East contract - previous delays to this work were the source of last October's profit warning. Management has been unwilling to ship the requested products until cash is received, but expects the "funding hurdles" blamed for the delay to be resolved shortly. As long as this big order does finally come good, Chemring will have a significant proportion of predicted profit for this financial year covered, together with 75 per cent of anticipated revenue.

Chief Michael Flowers is confident that appetite for Chemring's products and technology will remain robust in the war-torn Middle East, but is also cautious about how oil price weakness could affect order patterns from the region. Fortunately, with NATO customers soon to resume bigger spending, the group's reliance on these lumpy, unpredictable deals should ease.