Shares digital

With a healthy foothold in the US and unrivalled expertise the defence contractor is doing solid business

by Timon Day

Cobham (COB) 223p, Stop loss 178p

Shares summary

Has a great record as a high-growth defence subcontractor with strong cashflow, canny acquisitions and limited macroeconomic exposure. The shares should rise a further 12% to 250p on a 12-month view.

Business:

Largely defence and aerospace-orientated parts and systems supplier.

Vital stats:

Market value: £2.6 billion

Historic PE 2007: 18.8

Prospective PE 2008: 15

Prospective PE 2009: 13.3

Sector PE: 12.2

1-month relative strength: 14.7%

1-year relative strength: 34.5%

Yield: 2.3%

NMS: 10,000

Spread: 0.2%

Cobham took a brave step two years ago when it decided to sell its lower-margin civilian aerospace businesses and spend more than $1 billion on mostly US military companies. The success of this strategy is evident in this week’s half-year results. Underlying profits jumped 24% to £107 million and the order book is up a very healthy £500 million at £2.2 billion.

Defence companies were the best-performing sector in the last bear market and also look like being resilient this time around. This is chiefly because the sector is immune from the consumer downturn and macroeconomic problems dogging most other sectors, in addition to the fact conflict and political tension continue to break out across the globe.

The Russian invasion of Georgia, for example, comes amid increased signs of heightened tensions with former satellite countries in the old USSR. Critically, spending on armaments has risen rapidly in the last five years. A similar picture is found in China with double-digit rises in defence spending.

With such tensions the US defence budget is likely to rise still further. More than half of Cobham’s profits come from the US, so this scenario would be excellent news for the company and other UK groups such as BAE Systems (BA.) and Ultra Electronics (ULE).

Export markets to India, South Korea and Japan are also growing as these countries spend more on defence in response to problems in their regions.

Cobham is a sound tuck-away as its expertise in making dozens of different key components and systems means its position is almost invulnerable from competitors who lack expertise, innovation and experience.

Currently the strongest growth is coming from armoured vehicle intercoms and communication devices, and the missions systems for the multi-billion pound UK Future Strategic Tanker Aircraft order, for which Cobham is a key part of the winning consortium.

Cobham has also increased its presence in the fastest-growing US homeland security sector with the purchase of Sparta in June – the fifth purchase in the US for a combined total of $1.1 billion. Sparta will help with high-technology missile defence and other national security solutions.

Second-half profits will grow even faster as all the acquisitions will contribute for the first time. Nick Cunningham at Evolution Securities has raised his profit forecast by 5% for 2009 to 16.7p and predicts almost 19p is achievable in 2010.

Avionics and surveillance is neck-and-neck with defence systems to take the gold as the largest division with both pushing £200 million. Emergency locator transmitters are selling well in the US and aircraft-based satellite communication is on track. Cobham is also involved in installing covert surveillance systems in American cities.

Integration of all the acquisitions is either ahead or on target and the sale of the unwanted part of M/A Com should fetch almost £100 million. This will cut net debt from £360 million to well under £300 million, providing Cobham with plenty of headroom – perhaps as much as £350 million for more purchases.