Qinetiq strives to convert demand into earnings

Russia’s invasion of Ukraine has presented headwinds for many companies, either because of supply chain disruption or higher input prices as energy prices soar. 

For defence companies like Qinetiq (QQ), though, it’s been a tailwind. The invasion only took place towards the end of its financial year but the warning signs were present throughout its final quarter.

Chief executive Steve Wadey said recent events have led to “increased customer demand” for its services, with the invasion increasing the risk of direct conflict between NATO countries and Russia. He also highlighted a “proliferation of grey-zone warfare”, requiring more spending on advanced capabilities to deal with threats.

Qinetiq's results were hampered by budgetary decision delays in the US and a £14.5mn write-down relating to a (now closed) problem project but its order book grew by 7 per cent and it has begun this year with £900mn of revenue already under contract. It expects “mid-single digit” revenue growth and an operating profit margin of around 11-12 per cent, although capex is likely to be at the top end of its guided range of £90mn-£120mn as it embarks on a new growth plan.

The company spelled out long-term goals last month, setting a target of increasing revenue by 75 per cent to £2.3bn over the next five years, which is a similar pace to that achieved over the past six. It is leaning more heavily on its US and Australian arms sales to achieve this, targeting growth of 50 per cent from these markets and 30 per cent from the UK.

Achieving this without acquisitions seems unlikely, though. House broker Numis’ forecast is for organic revenue growth of 5 per cent this year and 4 per cent next. It has clearly been looking – last year’s result included a £3.7mn exceptional charge related to “unsuccessful acquisition activity” – but its net cash balance of more than £220mn means it has the firepower to move quickly if it spots a suitable target.

In November, we made the argument that Qinetiq’s shares were undervalued but they were bid up following the invasion and have outperformed peers. Even after a 7 per cent post-results slide, the shares are up 26 per cent year-to-date, double the 13 per cent gain made by the broader FTSE 350 Aerospace and Defence index.

As such, they’ve now moved in line with their five-year average and there’s a good argument to be made for banking gains until evidence emerges of fresh earnings momentum. Hold.

Last IC View: Buy, 266p, 11 Nov 2021