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Ultra post-warning sell-off overdone

It's bad karma for Rakesh Sharma as the electronics contractor is left bloodied but not broken on the back of a profit warning – and the departure of its chief executive
November 15, 2017

In a bid to shore up investor confidence, three directors in Ultra Electronics (ULE) – including chairman Douglas Caster and finance director Amitabh Sharma – snapped up around £134,000-worth of shares in the electronics contractor within 24 hours of a profit warning that sent its shares into a tailspin. Ultra’s market value contracted by around a fifth on the day of the announcement (13 November), closing at 1,230p a share.

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Although markets have been largely “satisfactory”, management warned that “mounting pressures in the funding of UK defence programmes” had resulted in project delays and cancellations by the MoD. These will contribute to a 4 per cent fall in organic revenues in 2017, while underlying operating profits of £120m are now expected against market forecasts of £132m. It was all too much for Ultra’s veteran chief executive Rakesh Sharma, who promptly resigned, leaving Douglas Caster in temporary charge of the FTSE 250 constituent.

The problems identified in the UK wouldn’t have surprised analysts, even though they only came to light in the fourth quarter. Indeed, the sudden emergence of these problems chimes with a view held by some market-watchers that the MoD is simply cutting those areas that are “predominantly short cycle and small-ticket procurement” – low hanging fruit. The MoD doesn’t have the same degree of flexibility on the big-ticket items that it’s pursuing, so a lag effect linked to sterling’s decline is a contributory factor, as most large programmes are priced in US dollars. Near- to medium-term funding issues for the MoD do not present a structural problem for Ultra, which also highlighted a 20 per cent increase in its order backlog year on year.

There have also been murmurings about accounting issues. However, Ultra still expects to achieve 80 per cent cash conversion, a healthy enough rate. Meanwhile the group confirmed that revenues and trading profits during 2016 would have been broadly unchanged under IFRS 15 rules, which should ease any concerns over revenue recognition.