Cohort plc (CHRT.L) Earnings Call Transcript & Summary

Hello. I'm Andy Thomis, Chief Executive at Cohort plc. I'm here with Simon Walther, Cohort's Finance Director, to take you through our interim results for the financial year ending in April 2023. We've refreshed the presentational structure a little, but for those who've attended one of these before, what follows will be very familiar. I will begin with an overview of the financial and operational highlights. Simon will then give more detail on the performance of our 6 businesses, and we'll take you through the cash flow. I will round off with some comments about the outlook and our expectations for the full year. So let me begin with the financial highlights. The big picture is that we've seen a very substantial improvement in performance compared to the same period last year. Revenue and profit were both up very strongly. Revenue was up by almost 1/3 to GBP 77 million. Adjusted operating profit and adjusted earnings per share both grew by a factor of around GBP 3 million to GBP 5 million and just over 10p per share, respectively. It was also a strong period for new orders. The group's total order book grew to over GBP 304 million with order intake of GBP 88.6 million. That is slightly behind the GBP 105.3 million we achieved in the first half last year, but that included a single order of almost GBP 50 million. At around 95%, revenue cover for the second half is the strongest we have seen. We now have orders that will generate revenue for a full decade out to 2032. Following these strong results, the Board has continued our progressive dividend policy with a 10% increase in the interim dividend to 4.25p per share. The cash position at the period end had moved to a small net debt. Simon will say more about the specific circumstances around this, but I'm pleased to say that by early December, we were in a strong positive cash position once more. Simon will give a more detailed breakdown of the performance of our divisions, but this slide shows the main factors behind the group's performance improvement. Starting at the top right, we've seen an especially pleasing result of Marlborough Communications. One important factor has been several U.K. hearing protection programs, all running in parallel. We've also seen strong sales of drones and electronic warfare equipment. The result has been a profit in the first half that almost matches the full year performance last year. Moving on, performance of Chess has been much better in this period with improved revenue and profit after a disappointing loss in the first half last year. It still hasn't reached the level of performance we would like to see, but it is very much on an upward trend. At SEA, we've seen steady profit performance, but a very strong order intake that leads and set well for the full year. These strong performances have been offset to some extent by EID, where revenue and profit have been poor. But moving to the final point, the underlying picture has been one of strong demand from both domestic and export customers. That has contributed to the good performance in terms of revenue, profit and orders. Boiling those points down to their essentials across the group, we saw 3 major factors that contributed to the positive outcome. Firstly, sales to the U.K. Ministry of Defense were much stronger than in the first half last year. That was particularly true at Marlborough Communications, where we saw very strong demand for equipment such as hearing protection systems and drones. To a lesser extent, we saw increased U.K. sales at Chess, ELAC and MASS. Taken together, that increase accounted for almost half of the revenue improvement. Equally importantly, the action we took to improve operational performance last year has continued to bear fruit. That has been particularly visible at Chess, where we've turned around some problem projects, and we've taken action to avoid future repeats. Some changes that we've made at SEA and EID aren't yet visible in their numbers, but we are confident that they will be in future reporting periods. Finally, the market dynamics are complex, but overall, they resulted in an increase in demand. For instance, the conflict in Eastern Europe has created both barriers and opportunities and is likely to do so for some time to come. But the net result in terms of both revenue and order intake has been positive. That has led to our record order book and it has also resulted in a good set of opportunities for future orders in the coming months. So that is the story of the first half in broad brush strokes. I'd like to ask Simon now to provide a more detailed breakdown of how our subsidiary businesses performed and to highlight 1 or 2 other financial details of the statement.

Thank you, Andy. Hello to you all. I'm Simon Walther, the Group Finance Director of Cohort plc, and I'm now going to take you through the financial results in a little bit more detail. On this slide and the next one, you will see a summary table for each business. The tables present the revenue, adjusted operating profit and order book in white with the comparative figure for the first half of last year in blue. Full details are shown in the appendix of the presentation that is available on our website. Starting with Chess, we have seen a welcome return to profitability here. This followed some changes to the management and controls of the business last year. The improved revenue was driven by increased export orders and delivered more efficiently on its order book. The mix of work did lead to weaker net margins. And as Andy stated, we continue to work on turning around some problem projects. As Chess enters the second half with 95% of its revenue on order, we expect them to have a much stronger year-end and its medium-term prospects for naval systems are good. ELAC, our German-based business, had a weaker first half than last year due to revenue mix. The first half deliveries dominated by work on its long-term Italian Sonar contract, where we have been cautious in recognizing margin. Sales of its higher-margin spares and support business, especially of legacy products were lower in part due to delays in German government export license approval. The government is finalizing new export legislation and that has taken resource away from processing the backlog of license applications. We do expect to see some easing of these delays in the coming year. Like Chess, ELAC is well-underpinned and we expect them to deliver a stronger second half, but its overall performance for the year will be lower than last year. SEA produced a solid first half performance. Their order intake was very strong, securing a record value support order for the Royal Navy, as we previously announced. The pipeline for further Naval system orders in the coming year is very good, both in export and domestic markets. SEA is also well-underpinned for the second half at around 90% and we expect them to deliver a stronger performance than last year. Turning to the other 3 divisions. Marlborough Communications had a very strong first half, delivering trading profit at almost the same level as a whole of last year. As Andy mentioned, increased activity with the U.K. [ MOD ] was a large contributor. Marlborough Communications enters the second half with most of its revenue expectation on order and with good opportunities for further wins in the coming months. We expect them to deliver a much stronger result for the full year than we saw last year and to lay a good foundation for the next financial year. EID, our Portuguese business had a weak first half or much lower revenue. This was a result of continued order delays, but EID has also suffered more from supply delays in turn impacting its own deliveries to customers. We do expect a stronger second half from EID as much of its revenue is on order. But overall, the performance for this year will be lower than last year. Looking forward, the pipeline is good and we expect some of the delayed orders to be secured in the coming calendar year and for EID to recover in 2023, '24. MASS remains our highest contributing subsidiary. Despite slightly lower revenue, it had a stronger trading profit due to the mix of work. MASS is nearly 90% underpinned for the second half. And overall, we expect it to deliver a result in line with last year's. Turning to the group cash flow. This declined in the first half following a large working capital build in the period. This was particularly visible at Marlborough Communications where the receivables were much higher due to its higher revenue. Also at ELAC and EID where we saw higher stock levels put in place to cover supply issues and that resulted in higher supplier payments. Partly offsetting these developments, it was pleasing to see the cash performance at Chess improve markedly. The timing of receivables reversed shortly after the first half period end and we have seen in early December, the Group's small net debt returning to net funds of over GBP 7 million. We still expect the year-end to be around GBP 4 million to GBP 5 million of net funds as we build stock and work-in-progress in the second half, particularly at ELAC. Finally, I'm happy to say we completed the acquisition of the minority of Chess at the end of November for GBP 1 million in cash. This will have a positive impact on the earnings per share in the second half of the year when we expect Chess' profitability to be much stronger. Thank you for your time, and I'll now hand you back to Andy to take you through the group's outlook.

Thank you, Simon. In this final section, I'm going to talk about the outlook for the second half and beyond, both in general terms and looking at the breakdown of our order book. So let's start with the main forces driving demand. One clear and unavoidable ongoing event affecting our markets is the situation in Ukraine. It has had a galvanizing impact on security policies worldwide. It has succeeded in unifying and revitalizing the NATO alliance that some have declared moribund. It has kept defense and international security a high priority in Europe despite the economic crisis following the COVID epidemic. And it has led to transfers of defense equipment to Ukraine that have depleted stocks and generated demand for replenishment. All of these factors have tended to generate increased demand. At the same time, the rapid change in priorities has disrupted some existing programs. Short notice overseas deployments have made it difficult for us to deliver to our customers in some cases. And customer countries are reevaluating their priorities. That is something we need to track carefully. The other major driving force is the tension in the Asia-Pacific region. That is being driven by the Chinese investment and its armed forces, especially its navy and its increasingly aggressive posture towards its Asian neighbors in Taiwan. At the Chinese Communist Party Congress in October, the national charter was amended, if I can quote "To resolutely oppose and contain Taiwan independence." The recent increase in internal position might make a special military operation look like an attractive option to President Xi, recent events in Ukraine notwithstanding. These may seem like quite abstract and distant considerations, but they have a tangible impact on Western defense businesses like Cohort. Looking at our domestic markets, the U.K. has launched a review of the Integrated Defense & Security strategy it adopted in 2021. That will report in the early part of 2023. It wouldn't be surprising if this resulted in an increased focus on the risk of a European land conflict. The concern about the potential international impact of Chinese naval expansion is unlikely to be reduced. In Portugal, we see an increasing list of domestic opportunities for EID, partly a result of an increased focus on defense. In Germany, ELAC has seen a boost in domestic orders and opportunities, offsetting some of the difficulties it's faced with export controls. In our export markets, most NATO countries have pledged to increase defense spending since February this year. We've seen a direct impact in some of our markets with new opportunities emerging and existing orders increased in scope. Further east, we see strong demand in the Asia-Pacific region. Australia has continued to commit to strong growth in defense spending under the Albanese government. Japan has just announced a doubling of its defense spending as a share of GDP by 2027. It's also joining the Anglo Italian next-generation combat aircraft project. Elsewhere in the region, spending has grown strongly, notably in the Philippines and Taiwan. NATO and Asia-Pacific are the regions we supply most. It's also worth mentioning that some of the factors that held us back last year, notably COVID restrictions and supply chain tightness have diminished even though they haven't disappeared completely. Overall, the demand picture of Cohort is positive. This slide shows the tangible results of that demand picture. At over GBP 304 million, Cohort's order book is the strongest we have ever announced. It's also the most long term and will generate revenue for a full decade out to 2032. In terms of size, SEA now has the largest order book at almost GBP 100 million. MASS and ELAC aren't far behind at around GBP 60 million each. All 6 subsidiaries have order books valued at over GBP 20 million, a very unusual position for MCL in particular. In terms of order book duration, SEA is also the strongest with contracts for long-term supply and support of naval systems. ELAC and MASS also have long-term revenue baked in. In the shorter term, we can see over GBP 82 million on order for the second half of the year and almost GBP 80 million on already for next year. We expect to see that number grow considerably in the coming months. Here, you can see the first 2 columns of the chart I've just shown in numbers together with a comparison against the same position last year. The 2 shaded columns show the revenue already on order for the second half of the year compared to the same position in 2021. One point that stands out is the much improved position of Marlborough Communications, where we have over GBP 18 million for delivery in the second half compared to around GBP 12 million last year. That's a very strong position to be in. And MCL is capable of winning and delivering more revenue before the year-end. Together with other improvements, that more than outweighs a weaker position at MASS and Chess compared to last year. At Chess, that weaker position in part reflects the greater level of revenue achievement in the first half. Overall, we now have 95% coverage of the consensus external revenue forecast for the full year on order. Of course, the GBP 82.5 million of revenue isn't guaranteed. Although it's on order, it could be delayed by supply chain issues, customer availability or various other factors. Nevertheless, it's a strong position to be in at this time of year. I can also say that we see some very good prospects for further large orders. That brings me almost to the end of our presentation and a summary of the main points I wanted to make. The first half of this year has been a significant improvement compared to last year. That's down to a combination of greater demand, especially from the U.K. and better efficiency. It's reflected in strong revenue growth and quite striking growth in profit and earnings per share. As a result of that performance, the Board has felt confident to increase the interim dividend by 10%. We have grown the dividend every year since our IPO in 2006. As well as strong revenue and profit delivery, we've also seen strong order intake in the first half. That gives very good order cover for the full year and beyond. There are still risks, as always, but we remain confident that we can return to growth this year, in line with the expectations we shared in July and again in September. Our record order book doesn't just cover the second half. It now provides solid revenue out to 2032. That reflects the positive developments and demand patterns we've seen, especially in the course of 2022. Finally, those demand patterns and in particular, the set of opportunities that we're currently working on, gives us the potential to accelerate our growth next year and beyond. In closing, I want to take the opportunity to thank our management teams and employees for their continued hard work. Let me leave you with the snapshot of how we see ourselves developing in future years. We've made considerable progress towards this vision from our earliest days on the market back in 2006. Our strategy continues to be to generate growth, both organically and through acquisitions, while paying a dividend that reflects our successful financial performance. We believe this offers the best long-term returns for investors while creating high-value employment and enhancing the security of the U.K. and its allies. Thank you for your attention.

[Operator Instructions] The first question is coming from Mr. Ben Bourne, calling from Investec.

Well done with those results. I have a few questions. Andy, where more specifically do you see the elevated levels of demand post Ukraine enduring for the medium term? Is it going to be in MCL, MASS, Chess or elsewhere?

Well, I hesitate to jump the gun on the U.K.'s review of the Integrated Defense & Security strategy, Ben. But I think the Ukraine conflict is certainly asking questions about the strategy that later countries have had for land defense and air defense in particular. And I expect to see new demand generated in those areas. I think particularly important is, if I can use the acronym ISTAR, intelligence, surveillance, target acquisition and reconnaissance. I think -- together with communications as well. I think some of the events in Ukraine have shown just how important those capabilities are, certainly equally as important as the kinetic capabilities of artery missiles and so on. So I would expect to see more demand generation in those respects as well. But -- and those are areas that several of our businesses have got quite a lot to offer. So MASS in terms of the electronic warfare operations support piece, Chess very strongly in terms of battlefield ISTAR. EID in terms of battlefield communications and certainly MCL across a whole range of capabilities. So yes, I do expect to see opportunities coming from that, but we'll have to wait and see for the sort of [indiscernible] of the U.K. and other countries to decide exactly how they want to respond to it. I think I'll add as well that the -- in contrast to that, the driving force that's coming from Asia is primarily maritime-based because I think the Chinese are investing very strongly at naval capabilities of Bluewater, surface navy and many, many submarines are very large submarine fleet. And those are creating challenges right around that region from Australia to Japan to the ASEAN countries. And of course, we have a strong naval assistance capability rather for both surface ships and submarines as well. And those are the reasons that I think we're quite well-placed in terms of demand patterns at the moment.

Perfect. Well understood. To what extent are we -- or can we benefit from element of urgent operational requirement pricing at the moment? I'm just thinking that we're off -- you mentioned we're offsetting quite a lot of macro challenges at the moment. And you do mention that supply chain constraints have been easing somewhat, but I'm of the belief that there are still challenges out there. So just a little bit around pricing, please?

Sure. Yes. Well, we've obviously seen the effects of inflation. And we've also seen effects from supply chain constraints, which have increased our delivery times and put our prices as well. And that has to be reflected in our pricing. But while the same was generally about pricing there is that we don't compete with our rivals on the basis of who's willing to accept the lowest margin. And we've got some structural cost advantages against the large defense primes in terms of our overhead. And in terms of our innovation, which enables us to be very competitive in those markets, which we're active. So we price at a level we think the market could stand. And of course, in our markets, the customer is constrained as well. So there isn't sort of limited opportunity to put price by any means, we don't do that. But we aim to achieve a reasonable margin. We don't tend to price [indiscernible] very adverse [indiscernible] strategically, which usually means too low. And we have some strategic cost advantages. Simon, anything you would add to that?

No, I don't think so. I mean one thing you highlight is the customer is somewhat limited, Ben, in who we can go to some of these technology solutions in this market. There are not defense showrooms all over the advisory I'm afraid. [Indiscernible] and are structural cost advantages.

Showrooms 3 hours flight east of [indiscernible]. Perfect. Price maker rather than taker. Lastly, Andy, you mentioned the prospects of further large orders in the pipeline. Could you just tell us in what areas, please?

I can't be too specific on these sort of measures. I mean they're commercially sensitive. And I made some general comments about demand patterns. But I can say that we do see prospects both domestically and further afield as well. I think it's probably worth me mentioning that there are particularly good set of prospects of EID. EID has had a rather unhappy first half of this year rather than last year, not looking great for them. But I'm really quite optimistic about the prospects in the medium term. Not only have they got some good domestic prospects, but they are building relationships, which have led to some very good export prospects as well. And I'm thinking both for their naval communication systems and also for sonar system in communications too.

We'll now take questions from Annabel Hewson, calling from Stifel.

I got 2, please, if I may. The first would just be on cash. And I appreciate the working capital build in the first half. We've seen that sort of reverse since we started H2. But more in terms of your cash terms within contracting, is there anything we can do there to help that process a bit or maybe see greater customer advances on some of the larger projects coming through? And second one is just more broadly on M&A in terms of what you're seeing, what you're sensing in terms of what the kind of the deals are sort of coming across your desk at the moment, please?

Okay. I'll take the cash question. Obviously, we have agreed terms with our customers. And as you know, our major customers, the U.K. MOD, I have to say a very good payer. If you provide you get your administration in order, you will be paid normally within 14 working days. The particular case in question this half year was that MCL, as you can see, is a very busy first half and a particularly busy last couple of months of the period. And it's just being able to get the stuff out of the door and then get the MOD pay. It was actually an administrative blip that the MOD themselves, where they were placing orders sort of quick and they could load them onto their system to get paid. So I'm pleased to say that all of the MCL debt was paid after the -- shortly after the half year point. In terms of other customers, generally on our export customers, we take obviously a more prudent approach with using sort of protective measures and that less of credit and advances. But no, generally, all of our customers place the terms providing what we require. It was just simply timing at the half year. And so we moved strongly into net homes already in the first few months of the second half.

And I'll take the question on M&A, and I was surprised is going to be a slightly general answer. But I can confirm that we do continue to have a strategy of growing both organically and by acquisition. And I can tell you that we do continue to get quite a stream of opportunities so they -- coming over my desk. But we also continue to be quite selective. So we see both U.K. opportunities and overseas opportunities to add businesses to the group, either as bolt-ins to our existing portfolio or with separate new members to the group. And when we find one that we can do the right deal with at the right price, then we'll go ahead and do it. But I can't make any commitments in terms of particular timing or size of the deal or nature of the deal or anything of that sort of metric you would expect. Sorry...

No, no, no, you can't be, but just to sort of follow on from that, I suppose it's in terms of sort of sellers' expectations around valuations. Are they sort of getting back to sort of more realistic territory or perhaps we're still seeing something of a premium in there?

I would say that we do occasionally see opportunities, which are plainly priced at a multiple that we don't think is realistic. But for the most part, when we're talking to organizations that actually want to do a deal, we're in a sensible place. It's more a question of the quality of business and the predictability of earnings and the prospects for growth. And if we could agree on those things, then generally speaking, we'll be able to find a mechanism which bridges any pricing gap.

[Operator Instructions] The next question is coming from Robin Speakman, calling from Shore Capital Markets.

Congratulations, gentlemen, on a strong first half performance. I've got 3 sort of questions. Just following on from questions on the sort of working capital cycle. Just for my knowledge, really, is there any sort of seasonality through the group where might you expect, if you like, your sort of working capital to peak during the year? Secondly, just again on acquisitions, just noting the geopolitical situation, has that impacted the acquisition prospect pipeline at all? Has it impacted prices? And thirdly, just on the supply chain issues, messaging on improvement is noted, but I just wondered how that has sort of impacted the order book? Have supply chain frustration extended the order book at all given rising costs may impact the margin delivery from the order book? And if so how long do you expect that to clear?

Okay. Well, I'll ask Simon to cover the point about working capital seasonality first and I'll pick up...