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Ultra Electronics is a play on US defence spend
UK-based defence and engineering company Ultra Electronics (ULE) generates at least half of its revenue from the US and on this basis should be feeling increasingly hopeful about its prospects.
A US budgetary process is underway and although it could prove lengthy, there is increasing confidence it will bring down the curtain on a continuing resolution which has capped military spending.
End to the stalemate?
Continuing resolutions are a thorn in the side of military contractors in the US as no new contracts can be initiated when the legislation is in place, although existing contracts can still be funded or renewed.
The legislation is introduced when Congress has reached a stalemate in negotiating a budget. Thanks to the resolution US defence spending was down overall by 0.5% in the first quarter of the year.
Analysts are keenly anticipating the fiscal 2018 defence budget request at some point this month. President Donald Trump has already signalled that he wants an additional $53bn for military spending next year, taking expenditure to $603bn.
In 2016 Ultra Electronics flagged concerns the Brexit vote could cause the UK Government to delay committing to major projects. Yet the company still increased its underlying operating profit for the year by 9.3%. This was ahead of the forecast from broker Liberum.
The company also surprised on the upside with its net debt position which was 5% better than expected, reflecting improved free cash flow.
Operationally the company looks well positioned thanks to its focus on, and expertise in, maritime and cyber warfare. These niches are neatly aligned with the spending priorities of the US and other major nations.
Trump plans to increase the US navy fleet size to 350 ships from 278, reflecting potential flash-points most notably with North Korea in the Pacific. Liberum analyst Ben Bourne adds that: ‘Most NATO members recognise the importance of naval (specifically antisubmarine) and cyber capability, both strengths of Ultra’s product portfolio.’
The US president is also trying to bring pressure on NATO members to meet their commitment of spending 2% of GDP on defence and if he is successful this could be a further boon for Ultra.
The stock trades on a reasonable-looking price to earnings ratio of 15.4 times using Liberum’s estimated earnings per share (EPS) of 139.8p for 2017.
In light of Trump’s initial problems of getting reforms through Congress, the increase in military spending is not a given. But this is a company that could see accelerated growth as the US bolsters its military might.
Ultra Electronics (ULE) £21.57
Stop loss: £17.25
Market value: £1.5bn