After taking the temperature of the sector at last week's London arms fair, broker Liberum Capital says US defence cuts remain a headache for the majority of UK-listed defence companies.
An in-depth research report identifies most upside in Rolls Royce (RR.), on which Liberum has a 'buy' rating and £13.40 target price, and most downside in Chemring (CHG), on which it has a 'hold' rating and 270p price targe. Dorset-headquartered Cobham (COB) is downgraded from 'buy' to 'hold' as the share price closes on its 320p target price and in response is down 1.3% to 297.3p today.
The report indicates US defence cuts, linked to the wider 'sequestration' of government budgets, could be an even-greater headwind in 2014 than they have been this year.
It says: 'With the new fiscal year less than a month away, there's currently no indication Congress is prepared to pass a new budget that would end sequestration. If no agreement is reached, the impact of sequestration will magnify (2013 $32 billion of cuts, 2014 $52 billion).
'Uncertainty remains on where the cuts fall and the phasing of sequestration. Some believe the US has as much as 25% too much infrastructure.'
It notes that any political cohesion in Washington on the Syria crisis could be a prelude to a deal to avert the next nine years of sequestration but adds that this 'seems optimistic'.
More promisingly, it suggests export opportunities to non-Nato customers can offset the pressure on Western budgets (see chart below - click image to enlarge).
It concludes: 'The presence of a South Korean warship moored next to the exhibition was telling.'
