Ultra Electronics — Update 4 August 2016

Ultra Electronics — Update 4 August 2016

Ultra Electronics

Andy Chambers

Written by

Andy Chambers

Director, Industrials

Ultra Electronics

Strategically positioned for growth

H1 results

Aerospace & defence

4 August 2016

Price

1,700p

Market cap

£1,195m

$1.32/£

Net debt (£m) at 1 July 2016

325.4

Shares in issue

70.3m

Free float

99%

Code

ULE

Primary exchange

LSE

Secondary exchange

N/A

Share price performance

%

1m

3m

12m

Abs

(3.46)

(3.63)

(4.23)

Rel (local)

(4.76)

(9.24)

(3.02)

52-week high/low

2,026p

1,595p

Business description

Ultra Electronics is a global aerospace and defence electronics company, with operations across three divisions: Aerospace & Infrastructure (25% of H116 sales); Communications & Security (33%); and Maritime & Land (42%).

Next events

Q3 trading statement

October 2016

Analysts

Andy Chambers

+44 (0)20 3681 2525

Roger Johnston

+44 (0)20 3077 5722

Ultra Electronics is a research client of Edison Investment Research Limited

Ultra’s interim results showed solid progression, boosted by FX and initial first half contributions from last year’s acquisitions. Earnings appear set to start growing again, although management retains a healthy element of caution with respect to market expectations of improving defence spending trends in the western world. Investment for growth has remained at a high level. The resultant increase in new products and contracts should start to drive improved organic growth from 2017 and support our fair value, which currently stands at 1,975p.

Year
end

Revenue (£m)

PBT*
(£m)

EPS*
(p)

DPS
(p)

P/E
(x)

Yield
(%)

12/14

713.7

112.0

123.1

44.3

13.8

2.6

12/15

726.3

112.4

123.9

46.1

13.7

2.7

12/16e

797.3

117.1

128.3

47.6

13.3

2.8

12/17e

821.4

121.8

133.5

49.5

12.7

2.9

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and share-based payments.

Flat defence markets offset by FX and M&A

H116 organic sales growth was -2.5%, adversely affected by the winding down of the ECU RP contract in the UK. The 2015 acquisitions made healthy contributions and the favourable move in $/£ towards the period end improved translation of US sales and profits (54% of H1 sales). Defence spending was healthy in Q1 but tailed off in Q2, particularly in the US. Prospects for a global uplift remain positive at present from 2017. Order intake improved, with 40% of 2015’s deferred orders captured during the period and good prospects for much of the remainder to be recovered soon. Cash conversion of 67% was a marked improvement on the prior year, and the £30m increase in net debt was largely the result of FX (-£21m).

Modest upgrade to revenues and profits

We have adjusted our forecasts for the expected sale of Ultra ID Systems, which has yet to complete, as well as the sharp fall in sterling, which boosts translation of US sales and profits. ID reduces sales by around £20m a year and profits by £4m, while an average $1.38/£ FX rate for FY16 adds around £45m to sales and £3m to operating profit. Management continues to guide for flat organic sales growth, having tightened the expected range to ±1%, boosted by the additional contributions of Furnace Parts and Herley, which should add around 5% to sales. Order cover for the year stood at 84% at the half year and improved further in July, allowing management to remain confident. FY17 should see improved organic growth picking up, as well as a likely, smaller FX benefit.

Valuation: Yet to fully reflect growth in defence

Our 2017 peer-based sum of the parts (SOP) has benefited from the continued positive performance of defence stocks in an uncertain market. In addition, prospects appear to be undiminished for defence spending despite Brexit, although this could be at least partially compromised by lower economic growth. Our peer-based SOP returns 1,979p currently and our capped DCF 1,971p an average of 1,975p.

H116 results

Order book, intake and prospects

Ultra’s order book stood at £785.7m at the end of H1, up 3.1% from the start of the year. However, this includes only firm orders not options, IDIQs or platform agreements, which are deemed to be “off order book”. However, the off order book business pipeline has expanded to around £2.4bn from £1.5bn previously, and many civil aircraft programmes are just at the start of a significant production ramp-up. Order cover improved to 87% for the year after strong order intake in July. It is these factors that led management to tighten the organic revenue growth target to ±1%.

Revenues and profits

Revenues in H1 grew £34.9m to £366.4m, with an organic decline of £8.2m (-2%) more than offset by translation gains, which added £10.6m, and acquisitions (+£32.5m). The £7.3m increase in adjusted operating profit to £57.7m benefited from £1m of FX translation, £4.3m from acquisitions and a £0.9m organic decline. There was also a somewhat exceptional benefit of £2.9m arising from the FX impact on US$ working capital held in the UK against contracts.

The S3 programme remains on track and some £7m should be spent by the end of 2016, with savings largely covering the below-the-line costs. There is significant work ongoing to identify additional process improvements and shared services benefits without compromising the agility and innovation Ultra has traditionally displayed as a Tier III/Tier IV supplier. Ultra continues to invest heavily to support future growth, with some £73.9m (H115 £75.1m) spent during the period on R&D (including customer-funded) and acquisitions.

With 54% of group sales in the US following the Herley acquisition, much of it of local origin, the translation of US profits should continue to benefit from sterling weakness. While this is largely a quantum not quality issue as far as earnings are concerned, it nevertheless increases the absolute amount of earnings. Every 1 cent improvement against sterling adds some £3m to sales and £0.4m to operating profit. Hence an average of $1.38/£ expectation versus $1.53/£ in 2015 is a major boost to earnings, with a more modest benefit likely in 2017 with the spot rate currently €1.32/£.

We have updated our estimates to reflect two factors: the dilutive disposal of ID and the benefit of the sharp fall in sterling. Our assumption of flat organic growth this year and a 5% additional contribution from FY15 acquisitions remains in line with tightened management guidance.

Exhibit 1: Ultra Electronics earnings revisions

Sales (£m)

PBT (£m)

EPS (p)

Old

New

% chg.

Old

New

% chg.

Old

New

% chg.

2016e

781.8

797.3

+2.0

116.6

117.1

+0.5

127.7

128.3

+0.5

2017e

807.2

821.4

+1.8

122.4

121.8

-0.4

134.0

133.5

-0.4

Source: Edison Investment Research estimates. Note: FY17 estimated old EPS restated to correct calculation basis.

Valuation: Growth potential not yet reflected

Our fair value calculation based on an average of our capped DCF methodology and a FY17 peer group SOP currently stands at 1,975p, significantly ahead of the current share price. There are potential risks to both the upside and downside in defence. The perceived wisdom is that both threats and thus global defence spending will increase. However, new political leadership could alter the dynamics on overall allocations and priorities within budgets. Brexit does not pose a significant direct threat, although the impact of lower growth may curtail budgets to a degree.


Exhibit 2: Financial summary

£m

2014

2015

2016e

2017e

Year end 31 December

IFRS

IFRS

IFRS

IFRS

PROFIT & LOSS

Revenue

 

713.7

726.3

797.3

821.4

Cost of Sales

(494.3)

(514.1)

(580.9)

(609.9)

Gross Profit

219.4

212.2

216.4

211.4

EBITDA

 

128.9

130.9

142.5

146.5

Operating Profit (before amort. and except.)

 

118.1

120.0

130.7

134.6

Intangible Amortisation

(3.4)

(3.8)

(3.7)

(3.6)

Exceptionals

(97.8)

(81.7)

(58.3)

(44.0)

Other

0.0

0.0

0.0

0.0

Operating Profit

16.8

34.5

68.7

86.9

Net Interest

(6.0)

(7.5)

(13.6)

(12.8)

Profit Before Tax (norm)

 

112.0

112.4

117.1

121.8

Profit Before Tax (FRS 3)

 

10.8

27.0

55.1

74.1

Tax

(15.0)

(9.8)

(16.9)

(17.9)

Profit After Tax (norm)

86.0

86.8

90.2

93.8

Profit After Tax (FRS 3)

(4.2)

17.2

38.2

56.3

Average Number of Shares Outstanding (m)

69.9

70.1

70.3

70.3

EPS - normalised (p)

 

123.1

123.9

128.3

133.5

EPS - normalised and fully diluted (p)

 

122.8

123.8

128.1

133.3

EPS - (IFRS) (p)

 

14.5

24.5

54.4

80.0

Dividend per share (p)

44.3

46.1

47.6

49.5

Gross Margin (%)

30.7

29.2

27.1

25.7

EBITDA Margin (%)

18.1

18.0

17.9

17.8

Operating Margin (before GW and except.) (%)

16.5

16.5

16.4

16.4

BALANCE SHEET

Fixed Assets

 

532.1

639.1

594.5

566.8

Intangible Assets

461.5

570.9

524.8

492.7

Tangible Assets

62.6

68.2

69.6

74.2

Investments

8.1

0.0

0.0

0.0

Current Assets

 

250.6

308.5

342.1

352.3

Stocks

73.7

81.8

91.7

97.3

Debtors

101.5

117.0

139.5

142.8

Cash

41.3

45.5

45.5

45.5

Other

34.1

64.2

65.5

66.8

Current Liabilities

 

(199.8)

(181.4)

(183.3)

(188.1)

Creditors

(199.8)

(181.4)

(183.3)

(188.1)

Short term borrowings

0.0

0.0

0.0

0.0

Long Term Liabilities

 

(279.6)

(447.5)

(441.4)

(394.0)

Long term borrowings

(170.8)

(341.0)

(347.6)

(299.8)

Other long term liabilities

(108.8)

(106.5)

(93.8)

(94.2)

Net Assets

 

303.4

318.7

311.9

337.0

CASH FLOW

Operating Cash Flow

 

97.8

85.4

85.6

131.1

Net Interest

(4.5)

(6.0)

(7.5)

(13.6)

Tax

(22.9)

(26.0)

(17.3)

(17.9)

Capex

(17.7)

(6.4)

(21.7)

(18.2)

Acquisitions/disposals

(104.5)

(171.8)

22.0

0.0

Financing

2.2

4.9

0.0

0.0

Dividends

(29.7)

(31.3)

(32.6)

(33.7)

Other

(5.6)

(13.9)

(35.1)

0.0

Net Cash Flow

(84.9)

(165.2)

(6.6)

47.8

Opening net debt/(cash)

 

42.2

129.5

295.6

302.2

HP finance leases initiated

0.0

0.0

0.0

0.0

Other

(2.5)

(0.9)

0.0

0.0

Closing net debt/(cash)

 

129.5

295.6

302.2

254.4

Source: Company reports, Edison Investment Research

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Copyright 2016 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Ultra Electronics and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.
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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

Edison, the investment intelligence firm, is the future of investor interaction with corporates. Our team of over 100 analysts and investment professionals work with leading companies, fund managers and investment banks worldwide to support their capital markets activity. We provide services to more than 400 retained corporate and investor clients from our offices in London, New York, Frankfurt, Sydney and Wellington. Edison is authorised and regulated by the Financial Conduct Authority. Edison Investment Research (NZ) Limited (Edison NZ) is the New Zealand subsidiary of Edison. Edison NZ is registered on the New Zealand Financial Service Providers Register (FSP number 247505) and is registered to provide wholesale and/or generic financial adviser services only. Edison Investment Research Inc (Edison US) is the US subsidiary of Edison and is regulated by the Securities and Exchange Commission. Edison Investment Research Limited (Edison Aus) [46085869] is the Australian subsidiary of Edison and is not regulated by the Australian Securities and Investment Commission. Edison Germany is a branch entity of Edison Investment Research Limited [4794244]. www.edisongroup.com

DISCLAIMER
Copyright 2016 Edison Investment Research Limited. All rights reserved. This report has been commissioned by Ultra Electronics and prepared and issued by Edison for publication globally. All information used in the publication of this report has been compiled from publicly available sources that are believed to be reliable, however we do not guarantee the accuracy or completeness of this report. Opinions contained in this report represent those of the research department of Edison at the time of publication. The securities described in the Investment Research may not be eligible for sale in all jurisdictions or to certain categories of investors. This research is issued in Australia by Edison Aus and any access to it, is intended only for "wholesale clients" within the meaning of the Australian Corporations Act. The Investment Research is distributed in the United States by Edison US to major US institutional investors only. Edison US is registered as an investment adviser with the Securities and Exchange Commission. Edison US relies upon the "publishers' exclusion" from the definition of investment adviser under Section 202(a)(11) of the Investment Advisers Act of 1940 and corresponding state securities laws. As such, Edison does not offer or provide personalised advice. We publish information about companies in which we believe our readers may be interested and this information reflects our sincere opinions. The information that we provide or that is derived from our website is not intended to be, and should not be construed in any manner whatsoever as, personalised advice. Also, our website and the information provided by us should not be construed by any subscriber or prospective subscriber as Edison’s solicitation to effect, or attempt to effect, any transaction in a security. The research in this document is intended for New Zealand resident professional financial advisers or brokers (for use in their roles as financial advisers or brokers) and habitual investors who are “wholesale clients” for the purpose of the Financial Advisers Act 2008 (FAA) (as described in sections 5(c) (1)(a), (b) and (c) of the FAA). This is not a solicitation or inducement to buy, sell, subscribe, or underwrite any securities mentioned or in the topic of this document. This document is provided for information purposes only and should not be construed as an offer or solicitation for investment in any securities mentioned or in the topic of this document. A marketing communication under FCA Rules, this document has not been prepared in accordance with the legal requirements designed to promote the independence of investment research and is not subject to any prohibition on dealing ahead of the dissemination of investment research.
Edison has a restrictive policy relating to personal dealing. Edison Group does not conduct any investment business and, accordingly, does not itself hold any positions in the securities mentioned in this report. However, the respective directors, officers, employees and contractors of Edison may have a position in any or related securities mentioned in this report. Edison or its affiliates may perform services or solicit business from any of the companies mentioned in this report. The value of securities mentioned in this report can fall as well as rise and are subject to large and sudden swings. In addition it may be difficult or not possible to buy, sell or obtain accurate information about the value of securities mentioned in this report. Past performance is not necessarily a guide to future performance. Forward-looking information or statements in this report contain information that is based on assumptions, forecasts of future results, estimates of amounts not yet determinable, and therefore involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of their subject matter to be materially different from current expectations. For the purpose of the FAA, the content of this report is of a general nature, is intended as a source of general information only and is not intended to constitute a recommendation or opinion in relation to acquiring or disposing (including refraining from acquiring or disposing) of securities. The distribution of this document is not a “personalised service” and, to the extent that it contains any financial advice, is intended only as a “class service” provided by Edison within the meaning of the FAA (ie without taking into account the particular financial situation or goals of any person). As such, it should not be relied upon in making an investment decision. To the maximum extent permitted by law, Edison, its affiliates and contractors, and their respective directors, officers and employees will not be liable for any loss or damage arising as a result of reliance being placed on any of the information contained in this report and do not guarantee the returns on investments in the products discussed in this publication. FTSE International Limited (“FTSE”) © FTSE 2016. “FTSE®” is a trade mark of the London Stock Exchange Group companies and is used by FTSE International Limited under license. All rights in the FTSE indices and/or FTSE ratings vest in FTSE and/or its licensors. Neither FTSE nor its licensors accept any liability for any errors or omissions in the FTSE indices and/or FTSE ratings or underlying data. No further distribution of FTSE Data is permitted without FTSE’s express written consent.

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

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

GVC Holdings — Update 4 August 2016

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