Defence company Chemring (CHG) has had a positive first half to 2018 heled by a higher operating margin of 7.9% amid an increased contribution from its countermeasures division.

This helped drive underlying pre-tax profit up 31% to £14.8m despite a 8% dip in revenues as the company moves away from its lower margin ‘Energetics’ division, essentially ammunition.

The company has also been a beneficiary of increased US military spending as Shares noted here and Chris Dyett, analyst at broker Investec says the key to Chemring’s fortunes will be ‘the US Programs of Record in sensors which offer significant upside’.

Chief executive Michael Flowers views this as important for the company which is waiting for customer decisions over chemical and biological detection systems - these are important to the Chemring’s long term growth in the US sensors market.

REBALANCING

Chemring’s supply of 40mm grenades aided 2017’s revenues due to large Middle Eastern contracts which aren’t expected to be repeated.

It was also supported last year by increased sales of low-margin non-standard ammunition worth £97.7m of sales or 18% of company revenues.

The company says its second half is usually better than its first. The fact that its first half earnings have come in slightly above market expectations bodes well for the company.

The market seems impressed as reflected by the company’s share price rising 3.5% to 224.5p on the results.

But these potentially lucrative contracts in countermeasures aren’t signed off yet, although the US Army seems committed to the company’s Husky Mounted Detection System which seeks out improvised explosive devices.

Flowers seems confident that the contracts will be signed but tells Shares it’s no good to count on revenue streams until they have been signed off.

ADJUSTMENTS

Ninety percent of its full year pre-tax profit in 2017 was wiped off by exceptional items. For the half year of 2018, 71% of its pre-tax profit is reduced by exceptional items although Flowers says this is within normal accounting rules.

The adjustments were made for the acquisition of Wallop Defence Systems. There is also intangible amortisation arising from business combinations of £7m.

According to forecasts by Berenberg, Chemring trades on 15.3-times 2019’s earnings which the investment bank says is a 20% discount to the sector.

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Issue Date: 21 Jun 2018