UK defence stocks are down across the board today. Ultra Electronics Holdings (LSE: ULE) shares have plummeted around 20%, and other defence specialists such as Babcock International and BAE Systems are also down, falling 4.3% and 2.3% respectively. So why the share price weakness?
Profit warning
The falls across the sector this morning are primarily the result of a profit warning from Ultra Electronics.
The £1.2bn market cap company, which develops technologies for the defence, aerospace, security, cyber and energy markets, said in a trading statement that although the majority of the group’s markets had been “satisfactory,” the UK has been “difficult.” Indeed, funding pressure on the Ministry of Defence has forced it to pause, cancel or delay numerous programmes, and a number of UK orders that Ultra budgeted for 2017 have been affected.
The group now expects revenue for the full year to be around £770m vs City analysts’ forecasts of £810m. The company also stated: “the Board would currently be minded to recommend a final dividend of 35p per share.”
Furthermore, it announced that Chief Executive Rakesh Sharma will step down with immediate effect. Chairman Douglas Caster, who was Chief Executive of the company from 2005 to 2010, will assume the role of Executive Chairman until a successor is appointed.
On the positive side, the company noted that it has made “good progress” in order intakes during the period, reflecting “an improving position” in the US, the group’s largest market. The order book for delivery in 2018 at constant currencies was over 20% higher than last year, positioning the group well for entering 2018.
An overreaction?
While we can take some positives from the group’s order book, today’s trading statement is clearly not great. The UK Ministry of Defence is a key customer for Ultra, making up around 7% of revenues last year. Investors are in an extremely unforgiving mood at present, and profit warnings are generally being punished quite harshly.
Having said that, I’m wondering if the 20% share price fall is an overreaction. The group generates over 50% of its revenues from the US, including 18% from the US Department of Defence. With the US Senate recently passing a huge $700bn spending bill, that should have positive implications for Ultra Electronics.
Of course, after today’s profit warning it’s harder to accurately value the company. The group advised that underlying operating profit for the full year is expected to be approximately £120m, but gave no indication of its expected earnings per share figure. Analysts had forecast 130.7p per share, however, this figure is likely to be revised downwards now.
On the plus side, a 35p final dividend would be an increase of 4.2% on last year’s payout. A dividend increase is a positive signal from management, although there’s no guarantee the company will pay out that figure. A 35p final dividend would take the full-year payout to 49.6p, a yield of around 4% at the current share price of 1,240p. It’s worth noting that Ultra Electronics has an excellent dividend growth history, having never cut its dividend.
With that in mind, Ultra Electronics is a stock I’ll be watching quite closely going forward. I’m bullish on defence as a long-term investment theme, and the share price fall may have created a long-term opportunity. Having said that, I’m aware that profit warnings often come in threes.
