Post Q1 thoughts for the next 3Qs
Now that we are through the Q1 earnings season, we have taken some time to reflect on what we have learned but more importantly what we expect for the remainder of the year for each of the 12 European A&D names we cover. In short, we believe that the next few quarters will be some of the most interesting we’ve seen in quite some time as the Civil aero ‘cycle’ debate will continue to rage at the exact same time as operational ramp-up risks are peaking. Then there is the proposed rights issue at Cobham; a potential management change at BAE; the c.100% H2 EBIT weighting at Rolls; and media reports on M&A at Safran to name but a few items of interest. We believe it’s a great time to look at the sector and see good value to be had on both the short and long sides. Increasingly, the value appears to be moving to the mid-cap names of Meggitt, Cobham and GKN, but Safran remains our Top Pick on a 12-month view. We retain our UW ratings on Rolls Royce, BAE Systems and Chemring. And we adjust our price targets on Chemring, Qinetiq and Ultra Electronics.
* Airbus (OW; PT: €75): The long-term multi-year earnings ramp-up is still valid, but shortterm pressures could weigh on performance until investors gain confidence that risks are subsiding. Orders, the A320neo industrialization and A350 ramp-up should remain in sharp focus through 3Q16.
* BAE (UW; PT: 400p): The annual divi servicing cost is £0.7bn vs. the -£0.1bn of net capex with internally funded R&D at <1% of sales. Given that the company is residing on the wrong side of credit metric thresholds at both Moody’s and Standard & Poor’s this appears unsustainable and unsupportive of consensus forecasts at this point in the ‘cycle’.
* Chemring (UW: PT: 120p): Despite its improved balance sheet after its rights issue, Chemring’s current valuation does not yet adequately reflect ongoing risks, in our view, at FY16E EV/EBITA of 10.1x and P/E of 12.6x with significant dependence on 2H16.
* Cobham (OW; PT: 210p): The recent announcement of the £500m rights issue offers a compelling opportunity. Post the dilution, the shares trade FY17 c9.8x P/E, c.7x EV/EBITDA or c1.2x EV/Sales for a 16% margin business with a sustainable >6% dividend yield, 10% FCF yield and at this point without the once burdened balance sheet.
* Meggitt (OW; PT: 410p): Of most interest at Q1 was the 7% organic growth in Civil AM (the highest margin part of the group), supporting our structural thesis over the medium term while its valuation also looks attractive (10.7x FY17E P/E, 4% dividend yield).
* Rolls Royce (UW; PT: 400p): We are struggling to reconcile the new guide for c£0m of EBIT in H1 given the company capitalises the losses on the sale of Civil OE equipment. This implies notable losses outside of new engine sales across the group. Perhaps Marine and Power Systems are particularly loss making in H1 and/or perhaps our well documented concerns around the profitability of TotalCare Aftermarket are valid.
* Safran (OW; PT: €78, DCF based): For those looking for a long-term value investment, Safran remains the most compelling name in our coverage by some distance.