The defence industry is changing rapidly. Gone are the days when armed combat simply involved having boots on the ground accompanied by heavy fire-power. Nowadays the military is far more clinical, possessing top-notch kit that can secretly gather intelligence, attack with precision and defend against cyber-warfare. Indeed, this shifting landscape was reflected in October’s UK defence cuts. Despite the £24.3bn budget being cut by 7.5% in real terms over five years, £650m of funds were allocated to enhance Britain’s cyber-security.
This is Cohort’s bread and butter. Developing and running cutting-edge information and electronic warfare systems for the armed forces accounts for 83% of turnover. Indeed, its state-of-the-art MASS division provides the clever technology that helps protect fighter pilots when they are under attack from, say, heat-seeking missiles. Meanwhile, its SEA unit designs advanced sonar equipment and observation platforms for satellites, along with monitoring radio spectrum to foil enemy spy networks.
Financially, the business is in fine shape. At the last trading update, the board said results were on track for the year to April 2011, with net cash closing at £1.5m in September on top of a healthy £110m order book. Moreover, Cohort has just been selected as the preferred bidder in a consortium led by Logica for the MoD’s Project Shepherd. This is a blue-ribbon contract to upgrade the UK military’s electronic warfare capabilities.In terms of the numbers, house broker Investec is predicting 2010/11 turnover and underlying earnings per share of £78m and 11.6p respectively. The firm also pays a 2.3p dividend. Personally I would value the stock on an 8 times EBITA multiple, which delivers an intrinsic worth of 115p per share.
Cohort plc (Aim: CHRT)
What are the possible pitfalls? Cohort is exposed to the usual concerns related to being a small defence contractor: the threat of future troop withdrawals from the Middle East and the economic cycle. There is also some uncertainty surrounding the exact details of the UK budget cuts (70% of revenues), along with the board’s turnaround plans for the underperforming SEA division. Lastly, the shares are thinly traded, so beware bidding up the price if you decide to buy.
All the same, armed with a solid balance sheet and stuffed full of clever technology, the group looks like a solid play on the importance of cyber-warfare. Indeed, given that chairman Nick Prest sold tank maker Alvis to BAE Systems in 2004 for £355m, there is every chance he will do something similar with Cohort. Interims are due out on 16 December.
Recommendation: SPECULATIVE BUY at 83.5p (market cap £34m)