Defence contractor CHG (Chemring) has fallen nearly 5% at the time of writing, having released its interims (http://is.gd/Qracjf) earlier today. Turnover is down 10.8%, and the company has posted a loss. The order book is down, re-affirming the problems that are being faced in the Defence industry.
New senior management have been appointed during the period, and the company notes “important progress made in performance recovery programme”. This is a situation that has interested me as a potential turnaround play from awhile back. I was very curious to see how it would work out. The answer so far is: not so well. It shows that, when it comes to turnarounds, you really have to try to pick your spots. New management and the insitution of recovery programmes can /potentially/ be very interesting as special situations, but there doesn’t seem to be a hard-and-fast rule. The trick seems to be to spot sector tailwinds, and try to determine how effective management are likely to be. Investors in turnarounds CHG, compared to travel agents TCG (Thomas Cook Group) have completely different stories to tell. Over the last year, CHG has underperformed the market by about 28%, whilst TCG has outperfromed by 609% (exc. rights adjustments, which I’m too lazy to calculate. Suffice it to say that your outperformance would be even stronger).
CHG’s CEO, Mark Papworth, sums up the ambivalence of prospects: “The Group has made good progress in the first half. The quality of our operations is improving, and while there is still much to do, we are confident that the Group’s performance is heading in the right direction. However, visibility generally, and the limited level of detail on the extent and nature of cuts to US defence spending in particular, makes forecasting increasingly difficult. For the current financial year, the Board’s outlook is towards the lower end of expectations.”
A scan through some of discussion on Stockopedia discussions (http://is.gd/ivTolI) on CHG make for interesting reading. Perhaps our first hint that all was not a happening deal occurred back in Jun 2010 when Stockopedia News headlined “Chemring hit by interim profit dip but points to record order book”. Edison Research headlined with “Strong H2 required”. Noise in the general scheme of things, maybe, but with the benefit of hindsight, they are statements that make one wince.
In May 2011, John Kingham (aka UK Value Investor), an investor who I admire strongly, posted his assessment (http://is.gd/oMF1CN) of CHG. Although he offered a number of positive and negative angles, in the end he concluded “Chemring has earned a place in my portfolio”.
In Nov 2012, I noted (http://is.gd/7H9Rva) that a bid by Carlyle Group had been abandoned. CHG was trading on a PE of 5, so the fact the bid was abandoned at an ostensibly give-away price should have raised a few eyebrows. It is not necessarily always negative, because bids can be abandoned due to problems of the bidder themselves.
Nevertheless, investors should probably have been skeptical at this point, and double-checked their expectations. I concluded that CHG “is going to be very tricksy and dangerous”.
CHG didn’t turn out to be as dangerous as I expected, although it has certainly been tricksy. Shorter-term investors could certainly have made above-average market returns if they got their timing right and had a good feeling for market psychology. For me, though, I expressed the view that it was the kind of share that I didn’t like. Although I could see the potential for a recovery, and a low share price, it’s one of those shares where I felt that I didn’t know which way was the right way to bet. From my experience, which is admittedly limited, I have learnt that, on aggregate, they do not make attractive investments. Sometimes they work, sometimes not. You generally end up with mixed, mediocre results; although on balance I think you end up a little ahead of the market. I think that a diverse portfolio is required if you buy into these situations, as the results are likely to be widely divergent.
Also in Nov 2012, Miserly Investor wrote (http://is.gd/TplVyY) on Stockopedia, headlining “The Cheapness of Chemring”, where he concluded: “the low price relative to earnings appears to reflect this risk and the yield provides the potential of a decent income return in the meantime. Given the excellent track of the company up to 2011 this may well be an opportunity to pick up a quality company at a bargain price.”
In Jan 2013, Miserly Investor backtracked a little (http://is.gd/ua1FfA) when he said: “I think that casts some serious doubts over the sustainability of the dividend.”
I have a lot of respect for Miserly Investor – so please don’t view my somewhat opposing stance on CHG as being dismissive.
In Dec 2012, CantEatValue wrote a piece (http://is.gd/YG6PgX) on Stockopedia entitled “My investment mistakes of 2012”. He included a very prescient quote on his discussions on CHG: “Industry slowdowns always start with order delays, then cancellations, then earnings downgrades.” Store that sagely observation in long-term memory!
In summary, I remain holding to my view that this share is still going to be very tricksy; and it’s not something I would be interested in buying until I was convinced in my own mind that the company has a clear path forward.
Happy investing to you all.