Qinetiq makes unsteady movements

Qinetiq (QQ.) is living up to its (somewhat contrived) name, showing signs of momentum in its first-half results.

The defence technology specialist reported a 31 per cent increase in revenue and a 35 per cent jump in underlying operating profit, helped by the contribution of Avantus Federal – the US-based cyber defence specialist it acquired for $590mn (£483mn) late last year. Even on a like-for-like basis, though, revenue rose by 19 per cent and its order book stands at a record high of £953mn.

However, as the 8 per cent post-results slide in its share price indicates, not everything went as well as it might. Operating profit on a statutory basis was 28 per cent lower, mainly due to the swing in value of a foreign exchange derivatives contract taken out last year to hedge against currency fluctuations while the Avantus deal was being ironed out. A year ago, Qinetiq recorded a gain of £42.9mn on the contract but this time it booked a £20.7mn loss.

Of greater concern, though, was that revenue from the US was “slower than expected”, making up just 22 per cent of the total, compared with 15 per cent last year prior to the Avantus deal. It blamed this on the ongoing federal budget dispute and some awards being held up by competitors challenging the bidding process. A consortium in which it played a part also lost out on a contract to build optionally-manned fighting vehicles for the US Army. Despite this, the company argued that a “significant step-up in contract awards” would lead to stronger second half US growth.

Cash generation was also disappointing, with Qinetiq’s underlying cash conversion ratio dropping to just 50 per cent, compared with 106 per cent over the course of last year. The company attributed this to “short-term timing effects” and said it should still meet its full-year target of 90 per cent.

The key consideration for investors is whether these are short-term blips. On the cash issue, it shouldn’t take too long to find out and if the company is true to its word, the shares should re-rate. Broker Shore Capital envisages a 30 per cent upside to the shares based on an analysis of its returns and its growth potential. Given a price-to-earnings ratio of 12 – below both its peers and its five-year average – we also think they represent good value. Buy.

Last IC view: Buy, 379p, 25 May 2023