12 Dec 19. Porvair to beat expectations. Specialist filtration business Porvair (PRV) announced that it expects to beat its full-year expectations, securing 13 per cent revenue growth, or 10 per cent on a constant currencies business. Porvair’s strong performance has been driven by gains in its aerospace and industrial division.
Despite £14m of investment, Porvair’s net cash position will come in at £3.9m, ahead of house broker Peel Hunt’s forecast level of £1.8m.
Peel Hunt forecasts full-year 2019 adjusted pre-tax profits and earnings per share of £14.8m and 24.9p, rising to £15.1m and 25.5p in 2020.
Porvair’s shares rose nearly 7 percent following its trading update. The company’s filter products are compulsory in some industries, which helps shield the business from a slowing industrial environment. Porvair has a record of growing earnings by more than 10 per cent a year and the update further underpins management’s reputation for being able to deliver. Buy at 618p. Last IC View: Buy, 610p, 18 Sep 2019. (Source: Investors Chronicle)
12 Dec 19. Aerospace & Defense: Gov’t Services Earnings; Revenues Continue to Run. CY3Q19 earnings wrapped up last week with generally healthy results, though margin variability remains. Solid revenues (~7%) and elevated BtB trends (~1.9x) supported a number of guide raises, the net of which had shares outperforming the market by ~5 points.
Government Services updates generally showed healthy results and outlooks, despite margin variability. With the conclusion of the earnings season this past week, updates broadly confirmed continued health in the group. Despite an ongoing CR, stability persists as evidenced by elevated BtB that came in at ~1.9x, continuing the healthy trend. This gives us confidence for potential revenue growth ahead, off quarterly results that showed ~7% growth YoY and indicated MSD levels into 2021. However, margins were mixed on idiosyncratic factors, though opportunities for improvement exist. As for cash generation and capital deployment, results were generally as expected with M&A focused capital deployment strategies largely unchanged. Finally, our broader views and stock preferences are largely unchanged with SAIC (OW) and PRSP (UW) as our most and least favored stocks and preferences in between being BAH (OW), followed by CACI, LDOS, PSN, and MANT (all EW).
Despite an ongoing CR, stability in the backdrop persists with BtB trends remaining elevated… Quarterly results along with management commentary reaffirmed our constructive view of the broader Government Services / Defense spending environment over the near- and medium-terms. Health in the environment was most evident via bookings where the BtB came in at an average ~1.9x for the group, maintaining recent trends and driving record-level backlogs, including at BAH (~$23B / up ~7% YoY) and LDOS (~$24B / up ~18% YoY) amongst others. Additionally, while views on the FY20 budget varied, cautious optimism prevailed on the basis of a 2-year deal covering both Defense and non-Defense spending.
Supporting topline organic growth at MSD levels. While the group generally beat expectations, growing ~7% on average, performance was wide ranging. BAH maintained its leadership, accelerating to ~13% growth YoY, where management pointed to strong demand in areas such as cyber and data analytics. On the lower end, PSN / SAIC posted ~1% growth YoY (organic and excluding EGL dis-synergies), where challenging comps resulted in subdued levels for PSN and $2B+ of contract award protests hampered SAIC. When looking out over the coming quarters and considering the aforementioned 2-year deal alongside backlog levels, our view is that elevated topline revenue growth should remain in the MSD range heading into and through next year.
Variability in margin performance remained alongside upside potential. On margins, similar to last quarter, performance variability prevailed with PSN / LDOS / BAH / MANT beating expectations (by ~75bps average) while PRSP / SAIC / CACI came up short (~25 bps average). Additionally, the variability was driven in part by a host on non-recurring items. More specifically for PSN, its ~8.7% adjusted EBITDA margin (vs. ~7.9% cons) benefited from performance incentive fees associated with contract milestones. As for LDOS, its ~10.4% operating margin (vs. ~9.6% cons) was supported by an arbitration award associated with prior business operations. On the laggards, PRSP saw ~16.8% adjusted EBITDA margins (vs. ~17.2% cons) that were weighed on by near-zero margin transition services and the sale of IT assets. SAIC’s ~8.3% adjusted EBITDA margin (vs. ~8.6% cons) result was driven by lower net profit write-ups that offset the benefit of cost synergies. And despite a somewhat mixed quarter for margins, we continue to see upside ahead for most. Our view is that accretive M&A (CACI / PSN), mix shift (BAH), and merger driven cost takeout (SAIC) all create potential from here.
Capital deployment schemes remain focused on M&A. Cash generation was solid for most Government Service providers on the quarter, supporting reiterations of capital deployment priorities/schemes with M&A generally top of list. That said, there were a couple items worthy of note, the first of which regarding BAH. The company again maintained a disciplined and balanced approach to its capital deployment strategy, effectively repurchasing no stock on the quarter, though announcing an off-cycle dividend increase of ~17% (or $0.04). This leaves ~$700M to deploy on share repurchase / M&A / special dividend between now and the end of FY21. Additionally, LDOS, also a balanced deployer of cash, maintained its approach by executing a previously announced $200M accelerated share repurchase in addition to tuck-in M&A on the quarter. Furthermore, the company indicated that its M&A pipeline remains robust with targets both large and small. Beyond that, PSN, MANT, PRSP and CACI were all active acquirers through tuck-in transactions, many of which were the closing of previously announced deals discussed on FY2Q19 earnings calls.
Net-net, we continue to take a balanced view of Government Services. Given health in the U.S. Federal budget along with robust backlogs, the setup for Government Services is supportive of continued topline expansion in our view. On the other hand, group valuations are in-line to above history (~12.5x EV/EBITDA on 2020) while competitive risks are on the rise from new entrants. Accordingly, our broader views and stock preferences remain intact. SAIC (OW) is our top pick given its solid FCF generation (150%+ conversion, $1.4B through CY2021) and notable synergy opportunities ahead via the recent Engility merger. PRSP (UW) is least preferred given significant contract recompete risk (NGEN ~15% of sales) and elevated leverage. Away from these names, our preferences are BAH (OW), followed by CACI, LDOS, PSN and MANT (all EW).
Estimates generally move up on a combination of guidance and bookings strength. We are taking up our estimates, driven mostly by results to date and backstopped by the aforementioned bookings trend and 2-year budget deal. Revenues are the primary adjustment whereas our view on margins remains generally unchanged and biased upward on synergies and repositioning within the value chain. Additionally, we adjust our multiples for account for the relative movement in the underlying market with a group EV/EBITDA target of ~13x on our 2020E (vs. S&P 500 at ~12x). This dynamic nets PT increases for nearly all and are summarized as follows:
- BAH (OW): PT of $79 (vs. $78 prior) on ~15.5x 2020E (vs. ~15.5x prior)
- CACI (EW): PT of $256 (vs. $235 prior) on ~12.5x 2020E (vs. ~12.5x prior)
- LDOS (EW): PT of $90 (vs. $83 prior) on ~13x 2020E (vs. ~12.5x prior)
- MANT (EW): PT of $70 (vs. $66 prior) on ~14x 2020E (vs. ~13x prior)
- PRSP (EW): PT of $23 (vs. $22 prior) on ~9x 2020E (vs. ~9x prior)
- PSN (EW): PT of $39 (vs. $36 prior) on ~12x 2020E (vs. ~11x prior)
- SAIC (EW): PT of $99 (vs. $99 prior) on ~13x 2020E (vs. ~13x prior)
Additionally, we updated our Defense models following solid earnings with conservative outlooks. As we noted following Defense earnings, the Primes reported solid results alongside 2019 guide reiterations / raises and conservative 2020 outlooks that were somewhat short of expectations. As such, we are revising our estimates, consistent with our previous commentary, while maintaining our preferences within the group (LHX / NOC at OW and LMT / GD at EW / UW). Furthermore, we continue to believe Defense stocks should be resilient in an uncertain backdrop. We adjust our multiples for account for the relative movement in the underlying market with a group target multiple of ~18x on our 2021E FCF (vs. S&P 500 at ~17x). This dynamic nets PT increases for nearly all and are summarized as follows:
- GD (UW): PT of $175 (vs. $172 prior) on ~13x 2021E (vs. ~13x prior)
- LHX (OW): PT of $259 (vs. $259 prior) on ~18.5x 2020E (vs. ~18.5x prior)
- LMT (OW): PT of $375 (vs. $364 prior) on ~18x 2020E (vs. ~17.5x prior)
- NOC (OW): PT of $449 (vs. $437 prior) on ~18.5x 2020E (vs. ~18x prior)
- RTN (++): See disclosures
11 Dec 19. Centauri, an Arlington Capital Partners Portfolio Company, Announces the Acquisitions of The Design Knowledge Company and PreTalen.
Arlington Capital Partners (“Arlington Capital”) announced that its portfolio company, Centauri, a leading provider of high-end space, intelligence, directed energy, and cyber solutions, has acquired The Design Knowledge Company (“TDKC”) and PreTalen, Ltd (“PreTalen”). The acquisitions more than double the number of Centauri employees in Dayton to over 300, establishing a major position in the technology focused market. Centauri is a fast growing solutions provider that has grown its employee base every year for the last 20 years, and expects to end 2019 with approximately 1,650 employees overall. TDKC has proven capabilities in microelectronics trust and assurance, space domain awareness, and advanced visualization for enhanced situational awareness. PreTalen’s core competencies are the related practices of cyber warfare, navigational warfare, and Positioning, Navigation and Timing (“PNT”) techniques and technologies in support of defensive and offensive operations to counter adversaries. Both companies are headquartered in Dayton, Ohio.
David Wodlinger, a Partner at Arlington Capital, said, “These acquisitions significantly strengthen Centauri’s portfolio of cyber capabilities, add a unique differentiator to its space domain awareness offering, as well as expand Centauri’s exposure to the rapidly growing cyber submarkets of vulnerability research and trusted microelectronics. The investments that we are making in Dayton highlight our commitment to this important region and are also emblematic of our overall strategy of building deep and robust presences in the communities that are home to our core capabilities.”
“Both TDKC and PreTalen have exceptional talent and share a common culture of innovation in pioneering new capabilities for the warfighter,” said Dave Dzaran, CEO of Centauri. “TDKC’s expertise in space domain awareness further strengthens Centauri’s existing space-related mission capabilities. Similarly, PreTalen is focused on the nexus of PNT and cyber warfare, and we are excited to facilitate collaboration with our operations in Dayton and other geographies to provide even more comprehensive solutions to our customers.”
Ben Ramundo, a Vice President at Arlington Capital, said, “We are incredibly excited by the opportunities unlocked by Centauri’s acquisition of TDKC and PreTalen. TDKC and PreTalen’s capabilities complement Centauri’s existing offerings, which will not only allow the combined entity to serve a greater scope of missions for space and cyber customers, but also broaden the career opportunities for Centauri’s growing employee base in the Dayton region.”
Greg Gerten, CEO of PreTalen, and Dan Schiavone and Eric Loomis, founders of TDKC, as well as both of their leadership teams, including Bruce Hart, will become a part of Centauri’s growing operations in the region. This investment in the Dayton region comes on the heels of Centauri’s hiring of Col. Elena Oberg, former Vice Commander of the Air Force Research Laboratory, headquartered just outside Dayton at Wright-Patterson Air Force Base.
Centauri is a high-end engineering, intelligence, cybersecurity and advanced technology solutions company headquartered in Chantilly, Virginia with offices Nationwide. We work with our customers in the intelligence and national security communities, helping them solve their most difficult challenges. Our agile, mission-first approach empowers our advanced technical and operational teams to meet the real-time demands and high-impact missions of national defense agencies across land, air, sea, space, and cyberspace. (Source: BUSINESS WIRE)
11 Dec 19. Cohort acquires Wärtsilä ELAC Nautik GmbH. Cohort plc, the independent technology group, is pleased to announce that it has agreed to acquire Wärtsilä ELAC Nautik GmbH (“ELAC”), a Germany-based market leader in naval surface ship and submarine sonar systems for a headline price of €11.25m.
- ELAC, a leader in sonar systems technology for naval surface ships and submarines, will join the Group as Cohort’s sixth standalone subsidiary
- Acquisition to be funded from existing cash resources and credit facility completed in November 2018
- ELAC shares highly complementary expertise, capabilities and technologies with SEA providing a significant cross-selling opportunity
- ELAC is focused on defence export markets, with naval markets accounting for 80-90% of revenues, with strong penetration in South East Asia and Europe, and adds Germany as a domestic market for the Group
- The acquisition is dependent on certain conditions being met, including German government approval. Subject to these conditions being met, the acquisition is expected to complete on or before 30 June 2020
- The acquisition is expected to be immediately earnings enhancing following completion.
Andrew Thomis, Chief Executive Officer of Cohort, said: “The acquisition of ELAC is a significant step for Cohort, adding a sixth standalone business to our growing and profitable portfolio. It is highly complementary to our core capabilities in defence and security, with a leading position in the attractive and growing submarine and surface sonar markets, strengthening and broadening the Group’s existing capabilities in maritime systems. We are looking forward to working with the ELAC team to realise the exciting growth opportunities that this transaction will create.”
Overview of ELAC
Founded in 1924, ELAC is a market leader in the design and development of innovative hydroacoustic products and systems, including sonar solutions, underwater communication systems and echo sounders for the global maritime market.
ELAC is headquartered in Kiel, Germany, employing around 120 people across engineering, production QA, test & integration, sales and product management. It has been independently managed by its locally based, highly experienced management team, who will remain in place following the acquisition.
ELAC has a global customer base, predominantly in Asia and Europe, with a growing focus in North and South America. Its customers include navies, shipyards, integrators and resellers, with naval markets accounting for 80-90% of revenues whilst 10-20% of revenues are generated from commercial and dual use markets. ELAC has sonar products currently in operation on various submarines and surface ships, including for the Indonesian, Singaporean, Taiwanese, Dutch and Portuguese navies.
ELAC’s offer comprises highly customised and innovative solutions for its customers, with a business model that focuses on open architecture products that are easy to upgrade and customise. Most supply contracts include services covering installation, consultancy, system integration, acceptance tests, updates, training and spare parts. The business is well invested with a purpose built, modern facility and streamlined processes.
Financial information on ELAC
ELAC has a strong pipeline and growing order book, enabling sales growth whilst simultaneously improving profitability through a cost reduction programme undertaken during 2019.
In its financial year ended 31 December 2018, ELAC generated revenues of €20.7m and EBIT of €1.4m. The order back log as at 31 October 2019 stood at €26.4m, of which c.€20m was for delivery during 2020 with some long-term orders stretching out to 2025. As at 31 December 2018, ELAC had total assets of €21.7m. ELAC operates a small defined benefit pension scheme, which is now closed to new members, but which may require modest funding by Cohort in coming years. As at 31 December 2018, it had a deficit as calculated under IFRS of €7.1m.
Based on the order book, prospects and cost reduction programme, growth in revenues and profitability is expected for the year ending 31 December 2019.
Background to and reasons for the acquisition
The acquisition of ELAC is in line with Cohort’s stated strategy to accelerate its growth by making targeted acquisitions, complementing organic growth, whether as standalone members of the Group or as “bolt-in” acquisitions to existing subsidiaries. The Board believes that this strategy of investing the Group’s cash resources partly in acquisitions will provide enhanced returns to shareholders.
ELAC meets the Group’s criteria for stand-alone acquisitions, which are focused on agile, innovative businesses that have reached a stage of development where there will be mutual benefit in joining Cohort. ELAC operates in a complementary market and technology space, has clear and sustainable competitive advantage and sees strong growth prospects.
The Board believes that the acquisition of ELAC will provide a number of benefits, including:
- Enhancing Cohort’s maritime defence system offering with market leading technology in surface ship and submarine sonars, underwater communication systems and echo sounders. With the addition of ELAC, the Cohort Group will have an exceptionally wide and capable offering in this high-growth market sector
Opportunity to take advantage of:
- strong submarine new build market, with growth in Asia and Europe with new entrants looking to specify independent suppliers such as ELAC; the naval export markets the Group (including ELAC) is focussed on are expected to reach US$150bn of spend over the next decade in Asia Pacific (excluding China) alone
- strong aftermarket, with global need to refit and upgrade sonars on existing submarine and surface platforms driven by local contractors and yard independent sub-contractors looking for sonars
- Bringing technology to the Group that is highly complementary to SEA’s Krait low-profile towed-array sonar
- A complementary and well diversified customer base with strong export exposure, including markets new to Cohort, with opportunities to introduce SEA to ELAC’s customers and vice versa
Terms of the acquisition:
ELAC is being acquired from Wärtsilä Corporation, a global leader in smart technologies and complete lifecycle solutions for the marine and energy markets.
Cohort has agreed to acquire 100 per cent. of ELAC for a headline price of €11.25m. There is no earn-out. The actual consideration will be adjusted to take into account the pension deficit and, based on completion accounts, the cash and working capital in the business at closing.
On completion, Cohort will pay an agreed initial consideration of €10.5m which is being funded through a combination of own cash and the Group’s £30m revolving credit facility, with the Group expecting additionally to draw down on its £10m accordion facility. On our current forecasts, the cash received with the business is expected to be similar to or exceed the total consideration payable to the seller. Accordingly, had the acquisition completed on 31 October 2019, the Group would have had net debt of approximately £5m.
Completion of the acquisition is dependent on certain conditions, including German government approval. Our expectation is that, subject to such approval and the other conditions being met, it will complete on or before 30 June 2020.
11 Dec 19. Kromek Profiting from terrorism risk and medical science. Sedgefield-based Kromek (KMK:20p), a radiation detection technology company focused on the medical, security screening and nuclear markets, has issued a bullish trading update alongside its half-year results. The second half weighting resulted in a flat cash loss of £0.6m on record revenue of £5.3m in the six months to end October 2019, but of far more importance is news that 90 per cent of analysts’ full-year revenue forecasts of £18.5m, up from £14.5m in 2018/19, is already secured. This not only underpins expectations of Kromek reporting second half cash profit of £3.3m on revenue of £13.3m, but highlights the operational leverage of the business as a higher proportion of incremental gross margin is converted into cash profit given the company’s relatively high fixed cost base.
The contract momentum shows no sign of abating. Having won contracts worth $100m (£76m) in the past three years, the order book is estimated at $90m, according to analyst Paul Hill at Equity Development. The move to a state-of-the-art medical-grade facility in Pittsburgh, and the seven-fold expansion of production capacity at its Sedgefield plant, means that Kromek has the capability to materially ramp up output as the order book grows. It’s easy to see why its cutting edge patented technology is proving popular.
In the medical imaging industry, Kromek’s cadmium zinc telluride (CZT) technology is being used by 11 OEM customers across single photon emission computed tomography (Spect), bone mineral density (to treat osteoporosis) and gamma probes (used for radio-guided surgery). For instance, Kromek has now commenced delivering its CZT detectors for a customer’s state-of-the-art medical imaging systems, having won the $58m seven-year contract earlier this year. There are many other contracts, too.
In the nuclear sector, Kromek has been awarded a raft of government contracts for its D3S ‘dirty bomb’ detectors, which are 10 times faster at detecting gamma and neutron radiation, and at a tenth of the cost of conventional detectors. Given the heightened global terrorism risk, which makes border security critical at ports, airports and international rail terminals, demand can only increase. Indeed, chief executive Dr Arnab Basu says that the US Homeland Security, a client of Kromek, now has public tenders out for 140,000 of these detectors. He also expects a current European government contract to be expanded significantly as the D3S detectors are rolled out across the country, city by city.
The same is true in the security screening market as original equipment manufacturers (OEMs) and government customers look to upgrade their dated X-ray imaging systems with high performance CZT technology for the baggage screening market. Kromek has four OEMs customers, one of which achieved the highest level of European liquid explosive detection certification for its cabin baggage scanner based on Kromek software and detectors, thus enabling the commercial deployment of the product. Another contract with a US client has been expanded 90 per cent.
Kromek’s share price hit a high of 39p after I initiated coverage at 25p (‘Follow the smart money’, 27 February 2017), but has fallen below my entry point since the end of September, perhaps the absence of news flow led to some [unwarranted] nervousness amongst investors. However, the bullish trading update should put any concerns to rest. Worth noting, too, is the positive divergence on the charts as the 14-day relative strength indicator (RSI) failed to confirm the series of lows in the oversold shares, suggesting a bottom is in place. Strong buy. (Source: Investors Chronicle)
10 Dec 19. Rolls-Royce’s biggest shareholder ValueAct quits board. Representative of activist investor steps down as non-executive director Rolls-Royce has struggled to contain the costs of a series of durability problems with its newest engine. Rolls-Royce’s biggest shareholder is quitting the aero-engine maker’s board, with the announcement that Bradley Singer, chief operating officer at activist investor, ValueAct, is stepping down as a non-executive director after nearly four years. His departure will spark speculation that ValueAct is preparing to sell down its holding in Rolls-Royce, which has struggled to contain the costs of a series of durability problems with its newest engine. ValueAct began reducing its stake in March, cutting the holding from 10.48 per cent to 9.35 per cent. In the meantime, Harris Associates, the US investor, has emerged on the Rolls-Royce shareholder register with a stake of close to 7 per cent as of last month, according to the firm. Rolls-Royce said it had been in communication with Harris over the summer. “Our dialogue has been constructive and amicable,” a spokesman said. Mr Singer was initially appointed for a two-year term in March 2016, after ValueAct revealed it had built a stake of more than 10 per cent in the UK’s blue-chip engineering company. The appointment sparked considerable resistance from some other institutional shareholders. However, the board insisted Mr Singer had been appointed in his own right, and brought solid expertise at a time when the company was recovering from a string of profit warnings.
ValueAct had become a shareholder at a time when Rolls-Royce was under pressure to sell or demerge its non-aerospace businesses to focus on aero-engines. The group sold its marine division in July last year. Mr Singer was initially bound by confidentiality agreements not to publicly criticise Rolls-Royce or its strategy. He was also only entitled to stay on the board as long as ValueAct maintained its stake above 7.5 per cent. The investors had agreed not to go above 12.5 per cent. However, some of those constraints were lifted last year when Mr Singer was reappointed to the board for another term. It remains unclear whether there are regulatory restrictions on ValueAct selling its stake in the near term, although there are understood to be none in the terms agreed with Rolls-Royce. In a statement, Mr Singer gave no reason for his departure. He simply said: “Since I joined the board nearly four years ago, Rolls-Royce has undertaken many significant initiatives and faced challenges head-on. The company is today on a solid path forward.” Rolls-Royce said it would conduct a “thorough search” for his replacement.(Source: FT.com)
BATTLESPACE Comment: Sources suggest that this move may well be a prelude to a bid, although Rolls is technically protected by the British Government Golden Share. Again, bad management is the root cause of Rolls’ problems, sacrificing engineering excellence for a bolstered share price. However BATTLESPACE has suggested for some time that a demerged Pratt & Whitney might bid for Rolls with promises, as with GKN, to keep jobs and technology in the UK. Certainly, without a bid, Rolls may need a Rights Issue to fund new electric and other engine developments if the current Trent 1000 problems continue.
09 Dec 19. Engineer Senior explores sale of aerostructures unit. British engineering firm Senior Plc (SNR.L) said on Monday it has been reviewing options for its aerostructures business, including a potential sale.
The news follows a Bloomberg report that said the company was reaching out to buyout funds and aerospace firms for the division and may seek at least £450m. Senior, which makes a wide variety of components used in commercial jets and counts Boeing Co (BA.N) as one of its top customers, in August posted a 16% drop in first-half profit as margins in its aerospace unit were hit by Boeing’s production cut of its best-selling 737 MAX planes. (Source: Reuters)
09 Dec 19. Hanwha Systems to acquire stake in US firm OverAir. South Korea’s Hanwha Systems has announced a bid to acquire a stake in US firm OverAir, a specialist in unmanned aerial vehicles (UAVs). Hanwha Systems said in a stock exchange filing on 6 December that it will purchase a 30% share in the company for KRW30bn (USD25m). It said the Committee on Foreign Investment in the United States (CFIUS) has recently approved the transaction. Through its investment, Hanwha Systems said it will develop vertical takeoff and landing aircraft in collaboration with OverAir, which was recently spun off from US aerospace group Karem Aircraft. The investment comes just a month after Hanwha Systems launched an initial public offering, raising USD1.1bn through the issuance of shares on the Korean stock exchange. (Source: Jane’s)