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The FTSE 250 defence group has an underappreciated growth opportunity
Thursday 05 Aug 2021 Author: Daniel Coatsworth

Investors often look for certain attributes when researching stocks to help spot the most attractive opportunities.

The list of desirable factors can include an improvement in a company’s financial position, operational efficiency gains, niche skills with limited competition, and underappreciated assets which means a company could be considerably more attractive than its headline valuation implies.

FTSE 250 defence group Chemring (CHG) ticks all these boxes. It’s a fascinating company which is often overlooked by investors who remain fixated on its troubled past. In doing so, they’ve missed the big turnaround that has resulted in a significantly more attractive business.

The firm also operates in a market that is the focus of takeover activity, with sector peers Ultra Electronics (ULEand Meggitt (MGGT) both subject to bids.


Chemring prospered during the Gulf War but suffered 10 years ago when troops were withdrawn from parts of the Middle East. A debt-fueled acquisition spree during its heyday didn’t quite go to plan and it was left with various integration issues and a weak financial position.

The company sold off some operations, tapped shareholders for more cash and implemented a new strategy to improve cash flow and margins. Investment in its manufacturing assets has helped to drive operational improvements; better cash flow has driven down debt; and the countermeasures market has recovered, working in its favour as the market leader in this space.

Furthermore, it has made substantial progress repairing its reputation which was damaged by operational safety issues. The lost time injury rate has dramatically fallen, helped by investment in automation.


Countermeasures and energetics are forecast by investment bank Jefferies to account for approximately two thirds of Chemring’s sales this year. These include products that protect against guided missiles.

The remaining third of sales comes from sensors and information, namely equipment to detect and defend against improvised explosive devices and chemical/biological weapons.

Just over half of 2020 sales came from the US (54%), with the UK accounting for 29%, Europe 10% and Asia Pacific 4%. Chemring does a lot of work for the US Department of Defense, with other customers including the UK Ministry of Defence, law enforcement agencies and defence contractors such as BAE Systems (BA.) and Lockheed Martin.


There are two parts of Chemring’s business that make it attractive from an investment perspective. The first is its involvement in the US Department of Defense’s ‘Programs of Record’, which helps to provide long-term revenue visibility into the 2030s.

Chemring is already involved in several long-term contracts involving explosive hazard and biological detection and the company should hear by early 2022 if it has secured a place on a further contract involving chemical detection.


The second element of Chemring which really appeals is its involvement in cyber security via a subsidiary called Roke. Odyssean Investment Trust (OIT) holds Chemring in its portfolio and co-fund manager Stuart Widdowson calls Roke a ‘hidden jewel’.

It is fair to say that only avid followers of Chemring may know about this operation, as the broader group does not get talked about as a cyber player.

In 2010, Chemring acquired Siemens’ UK defence electronics unit called Roke Manor Research for £55 million. Since then, the business has been built up to specialise in artificial intelligence, the protection of networked systems, data analysis and connectivity.

Roke is seeing double-digit growth in revenues per year and is incredibly important to Chemring’s future success. Its role in the group effectively provides a chance for investors to access the cyber security theme at a discount relative to mainstream players.


‘Good assets in the cyber security area can go for four to five times enterprise value to sales,’ says Widdowson. ‘Roke’s turnover is around £80m. (On that multiple), that alone is worth almost half the market value of Chemring despite the fact it is only 20% of group revenues.

‘There aren’t many high-quality cyber security companies left (on the stock market) as most have been gobbled up by bigger players. For example, Detica was bought by BAE for a hefty price. Roke is a hidden jewel in the business, definitely.’

Analysts at Jefferies argue that if Roke was valued at six times enterprise value to sales – which is still less than a lot of pureplay cyber security companies – then it could feasibly account for more than 70% of Chemring’s current enterprise value.

‘A lot of growth for Roke has come from selling more into the UK Government,’ says Widdowson. ‘That is likely to continue, but the real opportunity is selling to commercial organisations, and to the US which is the biggest market.’

In 2020, Roke won its first significant contract in the US for electronic warfare services. ‘We were told at the time that Roke was selected because the US purchasing organisation could not find anyone in the US who does what Roke does,’ reveals the Odyssean fund manager. ‘If they can continue that momentum, there is significant growth to go for.’

Chemring trades on 17.8 times forecast earnings for 2022. That certainly doesn’t reflect the opportunity for Roke, which operates in a fast-growing market, nor does it represent a business that has been whipped into shape and is now enjoying higher quality earnings. It’s time to buy the shares.

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