The defence sector is under siege. Government budgets are being trimmed and the gridlock in the US over the debt ceiling led to a budgetary stalemate. So it’s no surprise that aerospace specialist Cobham reported first-half sales down 7% to £892m, sending its stock into a tailspin.
Nevertheless, as illustrated by the 11 September terrorist attack, the wars in Iraq and Afghanistan, and the recent conflict in Libya, the world really isn’t a very safe place. Moreover, Cobham enjoys excellent positions in discreet niches where advanced technology is required and profit margins can be protected. Examples include making antennae, sensors, avionics, surveillance and missile systems for planes such as the F-35 Joint Strike Fighter. Cobham also supplies the air-to-air retractable hoses used to refuel combat aircraft. The firm has been selected to provide these to the Airbus tanker, which will go into service with the British, Saudi Arabian, Australian and UAE air forces. The firm will also fit the same kit to the Boeing tanker that was chosen by the US air force in a $35bn deal. “We’ll get about $1bn of that contract,” says chief executive Andy Stevens.
Impressively too, in spite of tightening budgets, Cobham’s first-half order intake was actually up 3% at £969m. In August the group bagged another $227m of work on the American missile defence programme – along with securing a four-year contract for the provision of flight inspections to Britain’s Ministry of Defence. So the order book presently stands at a hefty £2.5bn.
The Pentagon is tilting towards a more service-led approach to procuring equipment and maintenance packages. That trend should help Cobham as it is a master at upgrading and extending the life of existing gear. It’s also seeing good civil aviation prospects in India, the Middle East and South America, and is in the midst of a three-year plan to deliver £65m a year in savings.
Cobham (LSE: COB), rated a BUY by Oriel Securities
The City is anticipating 2011 revenues and earnings per share of £1.9bn and 20.6p respectively, together with a 6.6p dividend (three times covered). That puts the shares on a lowly p/e ratio of 9.1 with a decent 3.5% yield. I rate the stock on a ten-times EBITA multiple. Adjusting for the £68m pension deficit and £378m net debt, that delivers an intrinsic worth of 260p a share.
There are a few clouds on the horizon. Most obviously the planned defence cuts on both sides of the Atlantic, and the slowly recovering civil aerospace segment. Yet these headwinds are already more than factored into the valuation – and Cobham should be well insulated anyway, given its focus on niches. That’s borne out by the firm having been selected to provide refuelling systems to Airbus and Boeing – there are no credible competitors. Oriel has a price target of 215p.