The FTSE 100 outperformed the FTSE 250 by a wide margin last year. The UK’s blue-chip index ended the year slightly up, while the mid-cap index fell almost 20%. That was its worst performance since 2008.
As such, I’ve been turning my attention to mid-sized companies on the FTSE 250 that might offer me high-growth opportunities. And one defence stock has caught my eye.
Deception and protection
Chemring Group (LSE: CHG) creates advanced technology solutions for defence, security and law enforcement agencies. It also sells into commercial markets such as medical, transport and space (customers include NASA and SpaceX). Its products can be found in more than 50 countries.
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The company divides its business into two main segments. First comes Countermeasures and Energetics, which is made up of products used to deceive radar, sonar and other detection systems. For example, military aircraft use such devices to fool ground-to-air missiles. This division also sells aircraft safety components, such as oxygen masks and ejector seats for aircrew.
Its Sensors and Information segment supplies products to detect biological and chemical weapons, as well as software and solutions for electronic warfare. As a consequence of Russia’s invasion of Ukraine, the company sees a growing number of opportunities for its electronic warfare products in the international market.
Business momentum
For the fiscal year ended 31 October 2022, group revenue increased 13% year on year to £442.8m. Its underlying pre-tax profit was up 12% to £62.5m.
Chemring’s order book has expanded significantly, due to heightened geopolitical tensions. It increased 30% year on year, and now stands at £650.9m.
The company was also able to reduce its net debt by 73% during the period, leaving it at just £7.2m.
Finally, the dividend was increased 19% to 5.7p per share. The stock now has a forward dividend yield of 2.3%.
Optimism and risks
The outlook from management is understandably bullish. It said: “Chemring is well placed, with a robust strategy, market-leading positions across different geographies and sectors, and with products and services that are critical to our government and blue-chip customers around the world. Long-term prospects remain strong.”
One risk that should be pointed out is customer concentration. Over 50% of the group’s sales are in the US, while the UK accounts for about 30% of revenue. Any slashing of military budgets here or in the US over the next few years could impact the company’s growth trajectory. That said, the company is diversified across different sectors within both countries.
Also, the stock would presumably take a knock if Russia and Ukraine entered peace negotiations. Sadly, that doesn’t look like happening any time soon.
Beating the FTSE 250
The shares are up 3% over one year, but they’re actually down 21% since May. Over five years, the stock is up 58%, excluding dividends. That’s comfortably ahead of the FTSE 250, which has declined 6% over the same period.
Chemring’s market cap today is £812m, with each share costing 286p. That gives the stock a price-to-earnings (P/E) ratio of about 17. Its price-to-sales ratio (P/S) is 1.8. Neither valuation indicates to me that it’s overpriced.
Overall, I’m encouraged enough to start a position as soon as I have the capital available.
