CHG – Chemring – drops 7% on half-year report

CHG (Chemring) is a Defence company. It caught my attention because I noticed it as one of the top fallers for the day, and had been interested in it in the past.

It issued its half-year report today,
and Mark Papworth steps down as director, and Michael Flowers was promoted Chief Executive. When a company does poorly, I’m not keen on internal appointments. I prefer a new broom to sweep clean.

The half-year report did not please the market. Revenues are down, and so is the “underlying” operating profits (from continued operations). There were actual operating losses for the 6 months, compared with profits for the comparable period. The good news is that net debt is down due to disposals.

Looking at Stockopedia, I see that it is on a PE of 14.3, and is coming up in the Z-Score short selling screen. Its gearing is being flagged in red, as is interest cover. So it’s looking over-indebted, with mixed signals on its liquidity. Its quick ratio gets a green light, so presumably it is not in imminent danger of collapse. It has a Magic Formula grade of D-. Not ideal.

A mediocre PE and poor balance sheet makes this an easy Avoid.

The beauty of Stockopedia is that we can see a nice little history of what people wrote about it in the past, which can sometimes be fascinating. I’ll dip into them below.

Jan 2010 – Edison Investment: Solid growth continues
“we believe the current valuation remains attractive given the above-average sector growth offered and further acquisition potential” The price would have been around 650p at the time. I hope no-one bought on the strength of that piece.

Jun 2010 – Stockopedia News: Chemring hit by interim profit dip but points to record order book
“it expects to see a stronger trading performance during the second half. In addition, it said it remains on course to meet full year expectations”
But then again.

Jun 2010 – Edison Investment: Strong H2 required
“jitters surrounding defence spend, could provide an attractive opportunity”
Notice how its previous headline was that growth “continues”, and now it is “required”.

May 2011 – UK Value Investor: Leveraging global leadership
“I’m saying in this case that current earnings are abnormal and that for the next couple of years they will go down”. Those turned out to be very prophetic words. “I think Chemring has earned a place in my portfolio”. Oh. Many years of sustained growth, couple with high PE, seemed to be the attraction to the the author. There is a warning here. The author presented both positive and negatives on the company’s competitive advantages. On the one hand, he says “Chemring does not have a low cost durable competitive advantage”, whilst on the other he says “Being the market leader at anything typically means you have many advantages including economies of scale and being ‘known’ as a leader”. I think that this analysis overlooks one key point: if your market contracts, then any competitive advantage is of no particular help.

Nov 2012 – Mark Carter: Chemring – bid abandoned
OK, time for that joker Mark Carter to expend countless innocent electrons on his opinions: ” this one is going to be very tricksy and dangerous, despite the seeming attractive PE of 5.” The share price was around 258p at the time. Clearly, I was being sensitive to the possibility of walking right into a value trap. With the benefit of hindsight, my fears were well-founded. When a bidder walks away from a potential deal that is so “obviously” cheap, you should probably double-check your assumptions.

Nov 2012 – Miserly Investor: The Cheapness of Chemring
The author does a good job in analysing the pros and pitfalls, and concludes: ” this may well be an opportunity to pick up a quality company at a bargain price”. The author disclosed that he held some shares, which of course sums up a person’s convictions more than any other words can do.

Jan 2013 – Miserly Investor: Chemring revisited
“Sometimes Mr Market’s fears can be irrational but in this case I think he got it about right”

Dec 2012 – CantEatValue: My investment mistakes of 2012
My overall impression is that CantEatValue has achieved very enviable returns, so any reference to mistakes should probably be taken in a broader context. About Chemring, he says: “The lesson here then is to stay within my circle of competence”. Maybe, but do any of us really “know” anything?

Jun 2013 – Mark Carter: Chemring: market dislikes interims
As my mate Paul would say: “can you see the pattern yet?”

So, what’s my take on all this? Well, there could of course be some kind of war which gives Chemring a much-needed shot in the arm, so to speak; but I think that’s a risky way to bet. The best we can hope for is for it to go nowhere. I think it is more likely that we will see retrenchment, with a contraction of operations, and a need to pay down debt. I view the internal promotion of a Chief Executive as a bad thing. Either the company didn’t look for, or couldn’t attract, outside talent. Who knows, maybe dwindling profit and the debt situation will come to a head, creating a crisis situation. That’s just speculation on my part, though.

Over-indebted with mediocre PE. Avoid. 192.5p

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About mcturra2000

Computer programmer living in Scotland.
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