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03 Aug 17. Cobham announced strategic review in to Wireless and AvComm businesses. Defence electronics and air-to-air refueling specialist Cobham has announced a strategic review into its Wireless and AvComms business units in order to “optimise shareholder value”. The sale of the ventures would mark the latest in a series of divestments for the UK group, which has attempted to stabilise following a turbulent period of profit warnings, losses, and a depressed market valuation. Cobham divested five business units in 2015 alone. The group said in a 3 August statement that it had “concluded that Cobham is best placed to generate value when it focuses on its defence and commercial aerospace markets, in which it designs services, systems, and products.
(Source: IHS Jane’s)
03 Aug 17. Cobham remains vulnerable.
IC Tip: Sell at 136p
Bull points
• Improved defence spending outlook
• Possible takeover target
Bear points
• Pressure on profit margins
• Execution of US Air Force contract
• Legacy of Aeroflex acquisition
It’s obviously a work in progress at troubled UK defence contractor Cobham(COB), but there were some encouraging sings at the half-year mark. Revenues increased through the period, although this was down to positive currency translation effects. The group generated an operating profit of £34.7m, compared to a £12m loss at the same time last year. However, order intake was down significantly from Q216. The group completed a £500m rights issue in May, the second in a year. So, cash management, as much as trading performance will tend to occupy the minds of analysts going forward.
Last week’s cover feature (“Protect yourself from profit warnings”) has prompted us to re-evaluate our neutral stance on Cobham (COB). That article outlined the difficulties faced by the defence contractor since the 2014 deal to acquire Aeroflex, a US-based maker of microelectronic components and test and measurement equipment.
It set out the problems linked to debt levels following the acquisition and to contract delays and underperformance in some of the group’s business units. These problems culminated in February’s profit warning – the latest in a series since November 2015 – and precipitated a two-for-five rights issue, which was completed during the second quarter. The capital raising was undertaken as part of management initiatives to cut debt and improve the execution of contracts.
The trouble is that the criticism of the Aeroflex deal, at least in terms of its strain on the group’s finances, has obscured persistent trading weakness. True, Cobham’s troubles might have been symptomatic of a wider malaise in the defence industry, yet rivals such as Chemring (CHG) and Meggitt(MGGT) struggled for a time but managed to turn things around.
We think it boils down to a case of overstretch; management pursued an overly aggressive expansion strategy and got found out. The group’s chief executive and chairman were changed during the second half of 2016, but the underlying problems persist even though the outlook for global military budgets is now far more favourable. We think they will continue to weigh on margins for the foreseeable future despite recent remedial actions. The contractor has struggled with a development contract for new air-to-air refuelling tankers for the US Air Force, which, along with related issues at its wireless, integrated electronics and semiconductor solutions businesses, prompted £574m in write-downs at the time of February’s profit warning.
With 20:20 hindsight, industry watchers now question whether the price struck for the Aeroflex acquisition was justified given that its sales had been in decline. That’s a matter for conjecture, but a near halvin