Share prices for defence manufacturer Chemring (LSE: CHG) dropped by a third yesterdayafter anunexpected announcement from management that a proposed 100m deal to supplyammunition to Middle Eastern countries has been postponed to next year. The delay of thiscontract meant that the company lowered prot expectations by 16m to 33m for 2015.
Additionally, Chemring announced a 90m rights issuance to help pay down the companysstaggering debt load. With revenue last year of 356m, debt as of the end of October isestimated by management to be a whopping 155-165m. With interest payments of 15m in2015, the debt load has meant that the company has been constrained in re-orienting plans forfuture growth.
While dilutive for current shareholders, the rights issue will be a signicant benet for thecompany going forward when lower debt obligations will allow the company to focus on badly needed restructuring plans. Managementdoeshaveastrongrecordoffocusingondrawingdowndebt levels,withnetdebt falling from 248m in 2013 to current levels, signalling a competent head office
Even after dealing with the debt issues, Chemring still faces very signicant headwinds over themedium term. The U.S. Department of Defense is the companys single largest customer andthe United States market compromises just shy of 60% of revenues. While the proposed budgetdeal between Congress and the White House restores very moderate defence spendingincreases over the next two years, Chemring should certainly not expect the sky-high sales itonce booked at the height of the Iraq and Afghan Wars.
Growth areas for the company remain limited as its most protable and highest margin sector,Sensors and Electronics, is forecast to continue shrinking as the US and UK governments nolonger buy mass quantities of Improvised Explosive Device-detecting equipment, which wereneeded during the Iraq and Afghan conicts.
While Chemrings future remains tied to shrinking defence budgets in the developed world,other rms such as Cobham (LSE: COB) have been diversifying into other product lines todampen the impact of defence spending slowdowns. Since 2011, Cobham has increased commercial sales from 27% to 39% of revenue by expanding into high-end component manufacturing for the telecoms sector.
While Cobham and Chemring have both been stung by eight successive years of shrinking USdefence budgets, I foresee Cobham being a stronger play for long-term investors going forwarddue to its diversication into commercial sales, strong 3.65% dividend, and defence-relatedproducts thatare less reliant on direct combat use than Chemrings.
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Ian Pierce has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.