 The short-termism of investors seemingly knows no bounds. Rather than focusing on the growth potential of a stock, sector or region over a multi-year period, most investors appear to be far more interested in a time horizon that amounts to days, weeks or months.
Take, for example, defence company Chemring. The FTSE 250-listed company’s shares slumped by 13pc in just one day following the release of its full-year results last month. Although the results were in line with previous expectations, with revenue rising by 9pc and earnings falling by 3pc versus the prior year, investors were apparently concerned about a drop in the company’s operating profit margin, which declined by 70 basis points to 13.9pc, as well as its rather lacklustre earnings growth prospects for 2025.
However, the fall in the company’s operating profit margin was due to poor weather conditions that disrupted production, delays to the ramp-up of its automated facility and the extension of a legacy contract that was supposed to end during 2024 but which will now expire in 2025. None of those problems appear to be particularly fundamental or insurmountable, and while the company’s bottom line is forecast to grow by just 2pc this year, it is expected to subsequently expand by 15pc in 2026.
Looking even further ahead, Chemring’s full-year results stated that it is still aiming to reach £1bn in annual revenue by 2030. Given that the company generated £510m in sales last year, this would equate to annualised growth of around 12pc over the next six years. Even if it fails to dramatically increase profit margins during that period, it seems likely that it will deliver a double-digit earnings growth rate over the long run.
The company’s upbeat financial outlook is largely being driven by elevated geopolitical risks including the ongoing war in Ukraine and instability in the Middle East. They have prompted a dramatic shift in government attitudes towards military spending, with 23 Nato members expected to have met a target to spend 2pc of GDP on defence last year. This is significantly higher than the figure from a decade earlier when just three members met the target.
In Questor’s view, it would be unsurprising for recent trends towards defence spending to persist and even quicken under a new US administration. With interest rate cuts having already commenced in the US, Eurozone and the UK, GDP growth is set to be bolstered over the coming years. This should result in further underlying growth in defence spending across the developed world, thereby prompting a continued improvement in Chemring’s operating environment.
Although the company’s annual results showed that net debt surged from £14m to £53m, its financial position remains sound. It currently has a net gearing ratio of just 15pc, while net interest costs were covered 12 times by operating profits during the year. These figures suggest it has the financial capacity to further invest for long-term growth. With a return on equity figure of 12pc despite the company utilising only very modest amounts of leverage, it has a clear competitive advantage that bodes well for its long-term outlook.
Trading on a price-to-earnings ratio of 17.3, Chemring’s shares are by no means cheap when compared with many mid and large-cap UK stocks. Indeed, many investors may argue that they are rather expensive given the firm’s aforementioned lacklustre earnings growth outlook for the current year.
But when next year’s double-digit profit growth forecast and the company’s long-term aim to nearly double revenue over the next six years are taken into account, its shares offer good value for money in Questor’s view. Given the upbeat underlying outlook for the wider defence sector amid a loosening of monetary policy across developed economies, it would be unsurprising for the stock to deliver strong capital growth over the coming years.
It has already produced a 96pc capital return since first being tipped by this column in June 2019, substantially ahead of the FTSE 250 index’s 6pc rise over the same period.
Clearly, recent share price volatility could persist over the near term as investors struggle to focus on the long run, but with the company’s financial performance set to ultimately improve, further share price growth is likely to be ahead.
Questor says: Buy
Ticker: CHG
Share price at close: 333p |
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