Cohort — Update 30 July 2016

Industrials

Cohort

Portugal bolsters growth prospects

FY16 results

Aerospace & defence

30 June 2016

Price	297.5p
Market cap	£121m
€1.20/£
Net cash (£m) at 30 April 2016		19.8

Shares in issue	40.6m
Free float	70%
Code	CHRT

Primary exchange	AIM
Secondary exchange	N/A

Share price performance

%	1m	3m	12m
Abs	(18.5)	(18.3)	1.4
Rel (local)	(18.3)	(20.2)	6.5

52-week high/low

427.5p

290p

Business description

Cohort is an AIM-listed defence and security company operating across five divisions: MASS (26% of FY17e sales); SEA (38%); SCS (13%); MCL (13%) and the recently acquired Portuguese business EID (10%).

Next events

AGM	August 2016

Analysts

Andy Chambers	+44 (0)20 3681 2525
Roger Johnston	+44 (0)20 3077 5722

industrials@edisongroup.com

Edison profile page

Cohort is a research client of Edison Investment Research Limited

Cohort reported results in line with market expectations, as well as confirming the initial purchase of the 57% stake in EID in Portugal. FY16 sales and profits modestly beat expectations. EID also looks set to produce better margins than previously anticipated, further enhanced by FX. Growth therefore looks set to continue, with the strong balance sheet enabling further appropriate acquisitions, as well as a growing dividend yield. In the current market turmoil, defence has distinct attractions and our SOP-based fair value currently stands at 387p.

Year end	Revenue (£m)	PBT* (£m)	EPS* (p)	DPS (p)	P/E (x)	Yield (%)
04/15	99.9	10.2	20.5	5.0	14.5	1.7
04/16	112.6	12.0	25.0	6.0	11.9	2.0
04/17e	131.5	14.3	26.5	7.0	11.2	2.4
04/18e	143.2	15.6	31.3	8.0	9.5	2.7

Note: *PBT and EPS are normalised, excluding amortisation of acquired intangibles, exceptional items and one-off tax credit in FY16.

FY16 results exceed expectations

While revenues were broadly as anticipated, Cohort’s profit performance exceeded our expectations for FY16. Organic growth of 5% in sales and 13% in group adjusted operating profit is healthy in the current market environment, further boosted by full contributions from the previous year’s acquisitions MCL and J+S. Stronger than expected performances at MASS and MCL were primarily responsible for the beat. Adjusted EPS rose 33% to 27.18p (or by 22% excluding a one-off tax credit worth 2.20p) from 20.45p in FY15. Cash performance also exceeded expectations due to advances received on UK submarine orders before the year end, with net funds ending the year at £19.8m. The FY16 dividend was increased by 20% to 6.0p as expected, covered more than 4x by earnings.

Resilient defence prospects enhanced by EID

Cohort’s defence prospects in the UK appear to be largely immune to any direct impact from Brexit, due to the long-term nature and operational importance of its major programme exposures. Growth in new equipment budgets is expected to resume in FY19, but could be affected by slower UK economic development. However, export markets remain attractive and the addition of EID will provide direct access in the EU as well as new export markets. Cohort expects to increase the stake to 80% by the end of H1, by purchasing a further 23% stake from the Portuguese government for £3.6m (€4.4m). EID will make a 10-month contribution, continues to grow and is generating mid-teen margins, better than we had envisaged for the defence communications operation.

Valuation: Resilience and growth warrant better

While several UK defence peers in the UK have continued to suffer, Cohort delivers healthy growth. Prospects look bright with a single-digit FY18e P/E and a growing dividend yield having clear attractions at present.

Current trading and outlook

Positive FY16 results

Stronger than expected FY16 results were primarily driven by MASS and MCL. The former saw margins improve significantly on slightly lower sales due to a favourable mix, as secure network activity for education diminished in H2. Prospects for growth remain positive with a healthy pipeline of potential export orders. MCL benefited from increased product volumes with lower margins than the traditional support activity. These add greater sales visibility and support future growth, especially in tactical hearing protection where deliveries commenced to the British Army.

SEA continued to work through its strong order book and benefited from a full year contribution from the now integrated J+S during the year.

SCS was slightly constrained by the continuing UK defence budget controls and the absence of any Afghanistan operational contribution, which was still running down in FY15. SCS is expected to remain flat in the forecast period.

The group order book did decline as Cohort traded against its major contracts especially on submarine external communications systems (ECS). Order intake of £94.8m was achieved against a strong comparator (FY15: £114.3m, which included significant ECS orders). In addition, management has identified £60m of renewals that it anticipates in the current year. The backlog now stands at £116m (FY15: £134m), of which £65m is for FY17 delivery, giving FY17 order cover of 55% for the continuing activities. This excludes EID’s order book, where current year cover is said to be stronger than for the existing group. Management does not expect to be affected by the adjustment to single-source MoD business, as all contracts were either originally contested or are below the £5m value threshold.

EID acquisition progressing

The simultaneous announcement of the first stage of the EID acquisition in Portugal is also encouraging. Cohort has acquired its initial 57% stake from existing shareholders for £8.9m in line with the originally announced terms. It now expects to increase this to 80% by the half year through the purchase for a further £3.6m of a 23% government stake, which will then retain a 20% minority.

Performance of EID in 2015 was ahead of our expectations (sales €18.7m, EBIT €2.9m) and the company has continued to grow in H1 with low to mid-teen margins. It will be immediately EPS accretive, extends Cohort’s geographic reach and customer base, while adding technical and manufacturing capabilities. The fall in sterling following the Brexit vote also boosts the contribution on translation.

FY17 profit estimate increases modestly

Our current year profit estimate has been revised up modestly, largely reflecting the increase in margin for EID compared to our previous forecasts. As it only contributes for 10 months rather than a full year, the sales number declines slightly. FY17 should see healthy growth, although the one-off tax adjustment distorts EPS progression, and EPS actually decline marginally compared to our previous forecast due to the allocation of PPA intangible amortisation to the minorities.

Exhibit 1: Changes to previous estimates

	Sales (£m)			PBT (£m)			EPS (p)
	Old	New	% change	Old	New	% change	Old	New	% change
2016*	112.3	112.6	0.3	11.5	12.0	4.3	21.8	25.0	14.7
2017e	132.4	131.5	(0.9)	14.2	14.3	0.7	26.7	26.5	(0.8)

Source: Company reports; Edison Investment Research estimates. Note: Excludes FY16 tax credit for EPS.
*FY16 old sales and PBT forecasts exclude contribution from EID, which did not complete until June 2016.

The expectation is that, due to EID and the probable £5.5m acquisition of the MCL minority in the current year, net funds will reduce significantly to c £5m. We expect a return to cash generation thereafter. During the year Cohort signed a substantial new £25m banking facility that should support growth ambitions.

Implications of Brexit on defence

While in the near term Brexit may provide a boost to aerospace manufacturing through a sharp depreciation in sterling, the main concern is over the longer term commitment of global aerospace prime contractors to the UK. We see little likely change for the defence sector, which will be driven by existing long-term geopolitical risks and response strategies. However, any reduction in GDP could renew pressure on the UK defence budget, even if we maintain the 2% spending commitment to NATO. The danger for the longer term is that the key elements of strategic capabilities continue to be undermined, although in naval, for example, these seem to be well protected at present as well as by long-term collaborative programmes in other sectors such as air systems and missiles.

Valuation

The immediate impact of the Brexit vote has clearly been to affect market multiples and defence companies have not been immune. This has been exacerbated during H116 by a number of the company’s defence peers facing more company-specific issues that had led to significant de-rating ahead of the Brexit vote. We have moved the SOP valuation to a 2017 calendarised basis using our new FY18 forecast for Cohort.

Exhibit 2: Cohort sum-of-the-parts calculation (calendar 2017 basis) summary

	EBITA (CY17)	Tax (%)	NOPAT (CY17)	P/E (x)	Value (£m)	Notes
SCS	1.3	16.0%	1.1	12.6	14	10% discount to QinetiQ (14.0x)
MASS	6.3	16.0%	5.3	12.2	64	Average of QinetiQ (14.0x), Ultra (11.8x) & Cobham (10.7x)
SEA	6.0	16.0%	5.0	12.9	65	Average of QinetiQ (14.0x) and Ultra (11.8x)
MCL	1.9	16.0%	1.6	10.1	17	10% discount to Ultra (11.8x) and Cobham (10.7x)
EID	2.2	16.0%	1.8	12.9	24	Average of QinetiQ (14.0x) and Ultra (11.8x)
Less minority in MCL					-6	Carrying value
Less head office costs					-25	Calendarised central costs (12.4x PER)
EV					152
Net cash					5	FY17e net cash
Implied equity value					157
Shares in issue					41
Value per share (p)					387

Source: Edison Investment Research estimates

Exhibit 3: Financial summary

	£m	2013	2014	2015	2016	2017e	2018e
Year end 30 April		IFRS	IFRS	IFRS	IFRS	IFRS	IFRS
PROFIT & LOSS
Revenue		70.9	71.6	99.9	112.6	131.5	143.2
Cost of Sales		(47.6)	(47.8)	(70.0)	(77.0)	(79.3)	(81.7)
Gross Profit		23.2	23.7	29.9	35.6	52.2	61.5
EBITDA		7.9	8.8	11.0	13.0	15.1	16.4
Operating Profit (before amort. and except.)		7.3	8.2	10.1	11.9	14.3	15.6
Intangible Amortisation		(0.7)	(0.1)	(3.6)	(6.4)	(9.0)	(9.0)
Exceptionals		1.8	(1.5)	(0.6)	(0.3)	0.0	0.0
Other		0.0	0.0	0.0	0.0	0.0	0.0
Operating Profit		8.4	6.6	5.9	5.2	5.3	6.6
Net Interest		0.1	0.1	0.1	0.1	(0.0)	(0.0)
Profit Before Tax (norm)		7.5	8.3	10.2	12.0	14.3	15.6
Profit Before Tax (FRS 3)		8.5	6.7	5.9	5.3	5.3	6.6
Tax		(0.2)	(0.8)	(0.7)	0.1	(0.8)	(1.1)
Profit After Tax (norm)		7.2	7.7	7.8	10.6	12.0	13.1
Profit After Tax (FRS 3)		8.3	5.9	5.2	5.4	4.4	5.6

Average Number of Shares Outstanding (m)		40.2	40.0	40.1	40.6	40.6	40.6
EPS - normalised (p)		17.9	19.1	20.5	27.2	26.5	31.3
EPS - normalised and fully diluted (p)		17.7	18.7	20.0	26.6	26.5	31.3
EPS - (IFRS) (p)		20.8	14.7	14.0	19.1	14.6	14.3
Dividend per share (p)		3.5	4.2	5.0	6.0	7.0	8.0

Gross Margin (%)		32.8	33.1	29.9	31.6	39.7	42.9
EBITDA Margin (%)		11.2	12.3	11.1	11.5	11.5	11.5
Operating Margin (before GW and except.) (%)		10.4	11.4	10.1	10.6	10.8	10.9

BALANCE SHEET
Fixed Assets		38.8	38.2	66.2	60.5	65.3	56.3
Intangible Assets		31.5	29.4	55.7	49.5	53.0	44.0
Tangible Assets		6.9	8.5	10.3	10.2	11.5	11.5
Investments		0.5	0.3	0.1	0.8	0.8	0.8
Current Assets		36.0	39.6	40.3	53.1	45.4	54.7
Stocks		0.2	0.3	1.1	2.0	5.5	5.8
Debtors		19.4	23.0	19.5	28.0	32.0	33.5
Cash		16.4	16.3	19.7	23.1	7.9	15.4
Other		0.0	0.0	0.0	0.0	0.0	0.0
Current Liabilities		(15.1)	(15.0)	(26.8)	(40.1)	(35.1)	(32.5)
Creditors		(15.1)	(15.0)	(26.8)	(36.8)	(31.8)	(29.2)
Short term borrowings		0.0	0.0	(0.0)	(3.3)	(3.3)	(3.3)
Long Term Liabilities		(0.7)	(0.6)	(16.8)	(2.7)	(2.7)	(2.7)
Long term borrowings		0.0	0.0	0.0	(0.0)	(0.0)	(0.0)
Other long term liabilities		(0.7)	(0.6)	(16.8)	(2.7)	(2.7)	(2.7)
Net Assets		59.0	62.2	62.8	70.8	72.9	75.8

CASH FLOW
Operating Cash Flow		5.2	3.6	20.5	8.5	4.1	13.4
Net Interest		0.1	(0.9)	0.1	0.1	0.2	0.2
Tax		(1.1)	0.0	(1.7)	(1.8)	(2.4)	(2.4)
Capex		(0.3)	(2.3)	(1.1)	(1.0)	(2.1)	(0.8)
Acquisitions/disposals		0.0	2.5	(13.4)	(0.7)	(12.5)	0.0
Financing		(0.4)	(1.5)	0.8	(3.2)	0.0	0.0
Dividends		(1.2)	(1.5)	(1.8)	(2.2)	(2.5)	(2.9)
Net Cash Flow		2.3	(0.1)	3.5	(0.3)	(15.2)	7.5
Opening net debt/(cash)		(14.1)	(16.4)	(16.3)	(19.7)	(19.8)	(4.6)
HP finance leases initiated		0.0	0.0	0.0	0.0	0.0	0.0
Other		0.0	(0.0)	(0.1)	0.5	0.0	0.0
Closing net debt/(cash)		(16.4)	(16.3)	(19.7)	(19.8)	(4.6)	(12.1)

Source: Company reports, Edison Investment Research. Note: Normalised EPS in FY16 includes FY16 tax credit.

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