Cobham — Update 27 April 2016

Cobham — Update 27 April 2016

Cobham

Andy Chambers

Written by

Andy Chambers

Director, Industrials

Cobham

Back to the future

Aerospace & defence

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27 April 2016

Price

177.6p

Market cap

£2bn

£/US$1.46

Share price graph

Share details

Code

COB

Listing

LSE

Shares in issue

1,138.6m

Business description

Based in Poole in the UK, Cobham operates in commercial, defence and security markets. It has leading positions in air-to-air refuelling, aviation services, wireless, data communications (including satcom), defence electronics, life support and mission equipment.

Bull

Increased commercial exposure in growth markets, although some are subdued this year.

A dominant position in the growing aerial refuelling market, supplying Airbus, Boeing and Embraer.

Defence spending prospects starting to improve.

Bear

A high level of net debt, inflated by translation of US dollar-denominated lines to sterling, has initiated a £500m rights issue.

Operational issues in Wireless, Aviation Services and Advanced Electronic Solutions have led to another reduction in expectations.

EPS also diluted by disposals made in 2015.

Analysts

Andy Chambers

+44 (0)20 3681 2525

Roger Johnston

+44 (0)20 3077 5722

The FY16 profit warning and rights issue announced with the Q1 trading statement reflect the limited progress Cobham has made in recent years. The main problem appears to be a lack of core organic performance and reliance on an M&A-driven strategy to instil growth. These are similar criticisms to those levelled at previous management teams. Cobham now appears vulnerable as the technology positions and assets are attractive, but it looks like a slow process to drive value recovery in its current form.

Profit warning

While only reducing FY16 management expectations by £15m, the Q1 profit warning has an unfortunate resonance. Following a major acquisition, parts of both the acquired and ongoing businesses have performed poorly and reduced overall expectations. As a result, elements of organic growth go unrecognised and unrewarded. Unfortunately, this was a shortcoming of Cobham in previous guises; remember Westwind, SPARTA and others. Since 2011 the current management has spent over £1bn net on M&A. In that period, underlying EPS has declined by 12%, DPS has increased by 75%, cash conversion has fallen from 95% to 71% and net debt has risen 5.7x to more than £1.3bn. Of course, not everything has been under management’s control, the core issue of defence spending weakness being a case in point, and management has done well to respond to the challenges in its key market. In our view it is time for a fundamental shift in strategy and philosophy for creating value, possibly entailing at least a partial break-up to focus on core growth potentials that do exist. The order book is ahead at the end of Q1, both in Wireless where the largest issue arose in the period, and for the group overall.

Rights issue to deleverage

Management has indicated that the net debt to EBITDA ratio is likely to be close to the covenant limit of 3.5x by the end of H116. To allow management to focus on running the operations, it is to launch a rights issue to raise c £500m, reducing the leverage ratio to a more acceptable 2.0x. Focus on organic development from that point should be welcome, allowing returns from current investments in long-term projects such as the KC-46 and AMSA to be realised.

Valuation: Lacking stimulus

Cobham has once again failed to live up to market hopes and until a clear route to true organic development is mapped, we feel the market is unlikely to forgive and move on. Gentle deleveraging post the rights is unlikely to warrant a re-rating.

Consensus estimates

Year
end

Revenue
(£m)

PBT
(£m)

EPS
(p)

DPS
(p)

P/E
(x)

Yield
(%)

12/14

1,852

257.0

18.48

9.94

9.6

5.6

12/15

2,072

280.4

19.48

10.80

9.1

6.1

12/16e

2,020

211.4

18.55

11.58

9.6

6.5

12/17e

2,095

245.5

19.85

12.07

8.9

6.8

Source: Thomson Reuters Eikon consensus estimates

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Frankfurt +49 (0)69 78 8076 960

Schumannstrasse 34b

60325 Frankfurt

Germany

London +44 (0)20 3077 5700

280 High Holborn

London, WC1V 7EE

United Kingdom

New York +1 646 653 7026

245 Park Avenue, 39th Floor

10167, New York

US

Sydney +61 (0)2 9258 1161

Level 25, Aurora Place

88 Phillip St, Sydney

NSW 2000, Australia

Wellington +64 (0)48 948 555

Level 15, 171 Featherston St

Wellington 6011

New Zealand

Focusrite — Update 27 April 2016

Focusrite

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