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Cobham – Progress But Still A Lot More Hard Work To Do By Howard Wheeldon, FRAeS, Wheeldon Strategic Advisory Ltd.

 

 

Combined with an encouraging improvement in financial performance including a steep fall in net debt, Cobham has today in the first half year results reiterated full year underlying profit guidance.

A diverse and from my perspective, very interesting company that has large interests and the bulk of its revenue in the US, Cobham is a company has leading international positions in a number of differentiated defence and security based technologies. Now under a new generation of management, it is extremely pleasing to observe that, following a recent past history beset with predominantly self-inflicted wounds, the process of restructuring currently under way at Cobham will eventually see the company repositioned to resume growth. There is however, much more work to be done before then.

Necessary strategic and operationally based restructuring of Cobham was always going to take time and no one should be under any illusion that, even though the first-half results presented today demonstrate encouraging progress being made, there is still a very long way to go before CEO David Lockwood and his much invigorated senior management team can look back and say that was a ‘job well done’.

While there are positives aplenty to be found throughout the half-year statement, Cobham’s message to shareholders makes abundantly clear that risks and challenges remain. Such remarks do need to be taken seriously not just in regard of ‘unquantified customer damages assertions’ that appeared earlier this week but also in recognition that if done properly, strategic and operational restructuring properly executed can and most often does take three to four years to complete.

In respect positive takes from these result? Personally I would highlight the very significant improvement in the balance sheet and the single most important item of benefit. Two years ago net debt at Cobham stood at a whopping and unacceptable £877 million. A £500 million rights issue in the first half of 2017 brought that figure down to £460.8 million by the end of June last year. Interim results published today show that through a combination of efficiencies and disposals Cobham net debt stood at just £53.6 million on the 30th June.

Improving fundamentals and now having a sound balance sheet on which to move forward provides an additional plank of strength for Lockwood and his team to move forward through the remaining part of the restructuring process. Divesting of AvComm and Wireless for a sum of $455 million in the first half was a job very well done but more hard work still needs to be done.

Earlier this week Cobham told investors that Boeing was apparently withholding some payments in a dispute linked to Cobham’s involvement as a sub-contractor to Boeing on the build of 179 KC-46 air to air tanker refuelling aircraft. The programme which from a Cobham aspect is now coming close to delivery, has been beset with technical complications and delays over the past three years. Suffice to say that the rather too public spat that has emerged over the past week is as unwelcome as it is potentially damaging for Cobham, Boeing and the US Air Force customer.

Whilst I am clearly not in possession of all the facts, I am bound to dislike seeing any form of ‘bully-boy’ tactics used in a situation such as this. Withholding payment is certainly not the way to resolve a dispute and I sincerely hope that common sense will soon prevail. The first and overriding priority for Boeing and Cobham is to get the now proven KC-46 tanker refuelling capability delivered to the US Air Force. That is I am sure is what Boeing and Cobham absolutely wish to do. Withholding payment from a subcontractor and one that in this case provides such a vital capability element has the potential to harm both corporate parties in this dispute just as it could hurt the US Air Force customer.

Cobham which produces the KC-46 air to air tanker refuelling system has in the past taken several major financial hits on the programme and in the process has absorbed the vast majority of development costs. That the air-to-air tanker refuelling system development has faced technical and qualification challenges is not a point of argument here but in my humble view Cobham deserve recognition for the huge effort and the financial burden that they have taken on to get it right.

For its part and referring specifically to KC-46 work Cobham told investors today that:

We have continued to progress the contract, legal and regulatory issues that were provided for in the 2016 year end as exceptional charges. The KC-46 tanker programme is the largest of these and we announced an update on 26 July 2018 stating that qualification testing on the Centerline Drogue System (CDS) had been completed and submissions supplied to support achievement of Supplementary Type Certification of the aircraft, with CDS production deliveries having commenced in the period. 

In addition, the first Federal Aviation Administration conformed Wing Aerial Refuelling Pods (WARP) were delivered in June 2018 to support flight certification testing. Although there has been progress as outlined above, our customer, Boeing, has made as yet unquantified damages assertions relating to the programme and is withholding payment of Cobham’s KC-46 CDS and WARP invoices.  Cobham is formally disputing these assertions.

Additionally, we stated that completion of CDS qualification has taken longer and been more challenging than expected.  Qualification of the WARP is in its early stages with risks relating to schedule and cost.  Completion could take significantly longer than originally planned, and this increases concurrency risk as well as base cost assumptions. 

The latest estimate of the costs to complete has resulted in the recognition of an additional non-underlying charge of £40m in these Interim Results. The total remaining balances relating to the exceptional charges at 30 June 2018 was £113m (31 December 2017: £112m), including the £40m KC-46 charge above.  Of this total remaining balance £87m (31 December 2017: £82m) is included within provisions and £26m (31 December 2017: £30m) is within other working capital.  Net cash outflows in the period relating to these items were £44m (2017: £25m), with the exceptional items expected to be utilised mainly over the next two years.

For the record, Cobham reported revenue of £924.5 million and underlying operating profits of £90.4m. Allowing for the reassessment of certain provisions, this was slightly ahead of expectations. Cash generation was adversely impacted by a number of factors, including the cash utilisation of 2016 exceptional charges, an increase in working capital and the previously announced accelerated interest payments on debt pay-down.  As a result, free cash flow was £9.2m and as previously mentioned, the balance sheet was significantly improved through receipt of divestment proceeds of the AvComm and Wireless test and measurement businesses.

CHW (London – 3rd August 2018)

Howard Wheeldon FRAeS

Wheeldon Strategic Advisory Ltd,

M: +44 7710 779785

Skype: chwheeldon

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