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

[ Scott, ] thank you very much indeed. As Scott said, I'm Andy Thomis. I'm the Chief Executive of Cohort plc. It's great to have this opportunity to talk through who we are, what we do and our most recent set of results, which are for the half year ended on the 31st of October last year. So to begin, who we are and how do we provide value for investors? Cohort is a group of 7 businesses, providing technology-based defense products and services to the U.K. and to its allies around the world. We're particularly focused on maritime and land systems, but we also do do some work in the airborne field as well. Our business model aims to maximize the autonomy and independence of our businesses consistent with good regulatory and financial governance. And that means that decisions are able to be taken quickly and very importantly, close to the customer. It maximizes agility and innovation while supporting our businesses with a strong balance sheet and the market reach of the wider group. And we have no layer of overhead sitting between our small but experienced headquarters team in Reading and the operational management of the businesses. And that gives us a real structural cost advantage, too. We've got a strong record of growth, both organically and by acquisition since our IPO back in 2006. And in November, we announced the acquisition of our seventh business, EM Solutions, which we expect to push that growth on to the next stage. And I'm going to say a little bit more about that acquisition in a moment. Our organic growth has accelerated since 2022 when the Russian invasion of Ukraine shocked NATO Europe into a step change in defense spending, which continues to this day. And other worldwide tensions are also contributing to a strengthening demand picture. And one result of that was our largest ever contract, which we won in March last year from the U.K. Ministry of Defense, valued at GBP 135 million to provide Ancilia, which is our missile defense product for the Royal Navy's surface ships. And another result of that geopolitical position is a strong pipeline of future opportunities, and I'll talk you through some of those a little bit later in the presentation. But the ultimate hard evidence of growing demand is in our growing order book. As you will see, it hit a new record at the end of the first half of this year, and it's had a further significant boost with the acquisition of EM Solutions. Now that acquisition was funded using a combination of our existing cash resources, which were strong, some bank debt and also support from our investors in the form of a GBP 40 million placing. And the result of using that mix of capital is that we've maintained a very strong balance sheet with a low gearing. That's important because it gives our customers a lot of confidence to place large contracts with it. It allows us to invest in product development, capacity building and potentially, if good ones come along, further acquisitions. Finally, I should mention our progressive dividend policy. We've grown the dividend every year since our IPO in 2006 and by 10% in each of the last 3 years. And of course, that's valuable income for our shareholders. But just as importantly, we see it as a signal that we're not just developing interesting technology, but we're a successful trading cash-generative business, too. A little bit of background on our development since 2006. We've made a number of acquisitions over that period as well as some divestments to ensure that we remain focused on our core markets. Some of the most important transactions over the period were the acquisition of MASS in 2006, SEA in 2007, MCL in 2014, EID in 2016 and ELAC SONAR in 2020. And I'll say a little bit more about each of those businesses in a moment. And by the end of 2024, we developed into a group of 6 businesses with a revenue of over GBP 200 million annually and adjusted operating profit of over GBP 20 million. And that compares to adjusted operating profit of just GBP 3 million on revenue of GBP 34 million in our first full year on the market. I should emphasize that over that period, we've been very parsimonious with our equity. We issued no new shares at all apart from for employee share schemes from 2008 through the last year. And we funded all of the acquisitions in that period through a combination of operating cash and bank debt. But late last year, as I mentioned, we announced the acquisition of EM Solutions. And to fund that, we carried out a GBP 40 million equity placing in November. So a word or 2 about that acquisition. It's a very significant transaction for us. It's going to have a big impact on our product range, on our technological capability, our geographical footprint as well as our financial performance. EM Solutions provides highly capable satellite communications terminals, primarily for naval surface ships. And that is a challenging technology to develop. The terminals need to stay locked on to satellites and in the case of low and medium earth orbit satellites, which are moving across the horizon as a ship potentially rolls and pitches very heavily in seas that are rough. Demand for satellite communications is growing, particularly in advanced navies like those in Australia and the NATO countries. And this acquisition will be the first time that we've been involved in this technology, and so it provides us with access to an important new stream of growth. Now over time, the balance of our output has moved increasingly towards the maritime market. And this acquisition will add another important family of naval products to the portfolio. And that enables us to offer packages of systems to shipbuilders and integrators, which is another route to growth in larger contracts. Very importantly, bringing EM Solutions into the group will have geography-based advantages in both directions. Our position as a domestic supplier in 3 NATO nations and our strong export relations will help EM Solutions in markets that have become very important to them. And for the existing group, having a position in Australia's sovereign defense industry will greatly increase our ability to access that market, providing support to our products and potentially adding value as we actually manufacture those products as well. We recently announced that the transaction completed at the end of January, and we're already well into the process of integrating what is a really exciting new member of the group. So as I promised, I wanted to let you know a little bit about our other businesses as well. We have 2 reporting divisions, Communications and Intelligence and Sensors and Effectors. And taking Communications and Intelligence first. EID is our Portuguese business based just outside Lisbon, and it's focused on communications management systems for naval surface ships and also communications for land vehicles and deployed Army headquarters as well as soldier radios. MASS based in Cambridgeshire, provides highly specialized services in defense, including electronic warfare operational support, cyber defense and large-scale simulation-based training. Our business MCL works with overseas and U.K. partners to supply a wide range of communications and intelligence equipment, primarily to the United Kingdom, especially for urgent operational requirements. And as you can imagine, it's been very busy recently as a result of what's been happening in the world. I've talked about EM solutions. So moving on to Sensors and Effectors. We have CHESS, which provides optical tracking, surveillance and weapon control for both land and sea applications, especially for countering drones, which, as you can imagine, is an important capability at the moment. ELAC SONAR, which is based in Kiel in Northern Germany, is a world-leading provider of sonars for both surface ships and submarines as well as specialist hydroacoustic products like underwater communications. And finally, our business, SEA, which is based in the West country of the United Kingdom in Barnstaple and Beckington, provide systems for protecting ships from submarine and missile threats as well as communications for the Royal Navy submarines. Now in total, we've got over 1,500 employees, the large majority of whom are highly-qualified scientists, engineers and mathematicians. Overall, we offer a complementary and extensive range of technology-based products and services for defense customers worldwide. So I hope that's provided some useful background about the business. Now a little bit about how well this has all been working out in practice in our most recent reporting period. As I've mentioned, that is for the half year ended on the 31st of October 2024. And the summary is, as you can see from this slide, that it was a good first half, much stronger than the prior years. Revenue and operating profit were up very materially. And once again, we reported a new record order book. I can say that our prospects look good, and we expect to continue that growth in the full year and beyond. It was a very good period for new orders, which exceeded revenue, so growing the order book. And that, of course, is the best leading indicator for future growth. And by the end of the period, our order book has grown to over GBP 540 million. That order book covers more than 99% in effect or -- of the consensus forecast of our revenue for the year, and it will be generating revenue for us well into the 2030s. Finally, operating cash flow was also very strong, significantly exceeding profit and helping to push our net cash position up to nearly GBP 38 million. And of course, that was all prior to the placing and the acquisition of EM Solutions. And against that positive background, the Board has again increased the interim dividend by more than 10%. So a little bit about the market more widely and why it is that I say that demand for our products and services is growing. The 2 main driving forces for demand for defense equipment are the continuing conflict in Ukraine and the influence of growing Chinese assertiveness from the Indian Ocean all the way to Australasia. And adding to that mix is the instability, of course, in the Middle East. Now the conflict in Central Europe has driven demand directly as the NATO countries seek to help Ukraine resist the Russian invasion and also to develop their own armed forces, learning from the experiences that have been gathered in Ukraine. And many of those lessons learned in Ukraine are relevant to us. The increasing importance of electronic warfare, the need to counter drones of all kinds, the need for accurate and timely battlefield intelligence have all had a positive impact for us on both orders and prospects. There has, of course, been a lot of talk recently about the prospects for a cease fire in Ukraine. And that is something that we should all welcome if it stops the appalling waste of thousands of lives every week. Whether or not the current Trump initiative is successful in the end, there will be a cease fire in Ukraine. But in the absence of a complete defeat and occupation of Russia, which seems to be amongst the least likely of possible scenarios at the moment, that is not going to mean a reversal of the increases in defense spending that we've seen across NATO Europe. The persistent Russian threat and pressure from a much more transactional U.S. presidency will be powerful forces for sustained high levels of spending. The days of the 1990s peace dividend are sadly far behind us. Chinese aggression and investment in its defense forces has also had an impact on our prospects right across the Indo-Pacific region. The formation of the AUKUS alliance is one example of the response to that challenge, but we've also seen strong demand from Thailand, Indonesia and the Philippines. Japan remains committed to a doubling of its national security expenditure as a proportion of GDP to 2% by 2027. It's also joined the Anglo Italian next-generation combat aircraft program, and that bodes well from a European perspective for the opening up of a market, which [ is ] been dominated by the U.S. historically for many years. And our domestic markets have seen similar effects to those export markets, too. In the U.K., defense review is ongoing. We expect to see the output of that sometime around the summer, but the government has already committed to increasing defense spending to 2.5% of gross domestic product, and that commitment may have to grow further. In Germany, we can see the impact of the step change in defense spending that's taking place with increased local orders and opportunities for ELAC. And even in Portugal, one of the NATO members that still fall short of the 2% target, we saw some long-awaited orders in the early part of our 2024-5 (sic) [ 2024-'25 ] financial year, and we're very optimistic that there are more to come. Now I should emphasize that we're investing to respond to those changes in demand. We're increasing capacity at both CHESS and SEA by expanding and reorganizing our facilities. ELAC will be moving into a brand-new custom-built facility in the north of Kiel next autumn. And as our revenue continues to grow, we expect to see a gradual improvement in margins as our overhead will remain relatively constant. Now I mentioned that we continue to see some good opportunities, and I wanted to share a few of those with you. I'm afraid to say that in drafting this slide, it very rapidly gets overtaken by events because looking at the first of the bullet points there. In fact, at ELAC, we've just received an order for the sonar suite for the fourth of the 4 new Italian submarines that are being built by Fincantieri. We've already had orders for the first 3. And together with some other changes, that brings the total contract value to over EUR 100 million. And we're now starting discussions about 2 further possible new boats as well as upgrades to the in-service vessels. ELAC is also in discussion with the German Navy about upgrades to its antisubmarine frigates. That would be an important step forward with ELAC's domestic customers as most of its recent large orders have been for export customers. Moving to EID. As I've mentioned, having won some important orders early in the year, it's in discussion with the Portuguese Navy to provide communications for a new fleet of offshore patrol vessels that are being acquired. And it sees some promising opportunities from cooperation with the large Dutch civil and military shipyard, Damen. Following some initial success in Asia, SEA has multiple opportunities to provide an important product, it's KraitSense towed array sonar system to export customers. And it's also in discussion with BAE Systems and others about contributing to the next generation of Britain and Australia's nuclear submarines. And SEA has recently announced a partnership with a Danish company, Terma, to offer a complete anti-missile system for naval ships based on its Ancilia product. MCL sees multiple prospects for urgent operational requirements, most of which I'm afraid are too sensitive to go into any detail about. And again, MASS has just won a 2-year extension to its long-term contract called JCAST to design and run large-scale military exercises for the U.K.'s strategic command. And it's also got a growing relationship with a multinational defense alliance to provide secure digital communications. CHESS sees considerable short-term opportunities for its optical tracking systems for countering drones. It's doing so at the moment through a very successful partnership with Rheinmetall and it's building other partnerships, too. And finally, EM Solutions has a promising list of opportunities in Australia, Europe and East Asia. It will shortly begin deliveries covering almost the entirety of the Australian surface fleet, and there's a lot more than that in the pipeline, too. Now all of these, of course, are prospects rather than orders. So we can't be certain about their value, about the timing, indeed about the probability of winning them. But I hope that this paints a picture of what is a very strong demand and opportunity pipeline for the group more widely. Now I talked in broad terms about markets and opportunities, and this slide shows the tangible results of that demand picture. Now these figures show the Cohort order book at the half year-end for 31st of October, so they exclude the contribution from EM Solutions. And we're working on the completion accounts for EM Solutions now, and we'll make their contribution to the order book public at the appropriate moment. But at over GBP 540 million, that order book is stronger than ever. A very substantial element of that feeds into the second half and already into next year. But that also includes over GBP 280 million of order cover for 2026, '27 and beyond and guarantees a solid flow of revenue well into the next decade. The larger part of that order book, as you can see from the color breakdown, sits with our Sensors and Effectors division. I expect that to remain the case, but that balance will be redressed to a certain extent with the addition of EM Solutions. Now before bringing this to a conclusion, I wanted to say a brief word about our shareholder register. Our largest shareholder is one of the founders of the business, Stanley Carter, who is a long-term holder. Nick Prest, our Chairman, also remains a significant shareholder. But the backbone of our shareholding is a very strong, high reputation list of institutions. The largest are Schroders and Liontrust and Canaccord Genuity, but other long-term holders include Citi Asset Management, Herald and Unicorn. And it was really very good to see some important new institutions coming in at the recent placing. And those included BlackRock, Lazard and Royal London. So that's almost all I wanted to say. It's been another pleasing period in terms of performance that sets us up well for the year as a whole. One consequence of that is that once again, we've been able to increase our interim dividend by more than 10%. The acquisition of EM Solutions will take Cohort to the next stage of our development. It's a good deal financially. It will broaden our product range, our technical capacity and our geographical footprint in a very beneficial way. The strong balance sheet gives us the flexibility to address and to invest in facilities and product development, potentially in new acquisitions as well. And finally, perhaps most importantly, we've achieved another record order book, and we see an excellent pipeline of further opportunities ahead. Thank you very much indeed for your attention, and I'll be very happy to answer any questions you may have now.

Wonderful, Andy, thank you for the presentation. Very interesting indeed.

[Operator Instructions] So moving on to some of the questions that we've had submitted so far. First one is congratulations on the acquisition of EM Solutions. How long did the acquisition take? And how long will it take to integrate? And how will this be done?

Yes, that's an -- it's an interesting question. Acquisitions are never a quick process. And if you want to measure the time from the very first sniff of a possibility through to completion, I think that runs from May through to November. But I mean, there are multiple stages in that, of course. And the final stage was approximately 2 months when we negotiated the agreement, completed due diligence and brought it to completion. So yes, a long process, but one I think that's very well worthwhile.

And how will the acquisition of EM Solutions accelerate growth?

I've mentioned a little about that in the presentation. I mean, firstly, it's got access to a growing market itself with a number of important growth opportunities. It has a large order book based on the work it's doing in Australia. But beyond that, it's been exporting very successfully into Europe, and we see wider opportunities, too. But also, there are those geographical advantages whereby it will provide a route into Australia. In Australia, it's becoming more and more important to be able to get local support for defense products. And so it will enable us to provide that for our other products. And the close relationships that we've got in NATO Europe and wider export markets will help EM Solutions in their export drive too.

Thank you, Andy. Now over the last couple of weeks, there's been a fluctuation in share price. Does the market see the value in the acquisition of EM Solutions?

Well, I think the measure of the market's view of the EM Solutions acquisition is best gauged by the placing, which was very heavily oversubscribed back in November, as indeed was the retail element. We've seen some fluctuations in defense stock prices over the last few weeks with all the dramatic news coming out of Washington and Europe and Munich. And I think that, that has been the main effect on defense stocks indeed more widely than Cohort. And as relatively a small cap business, we tend to see those amplified a little bit. Indeed, I would suggest anyone relying on the day-to-day price of the Cohort share price as a gauge for the international defense field is likely to be misled a little. But in broad terms, in the longer term, the share price does converge on a sensible view of value. So I'd just urge anyone who's worried about that to stay calm.

Thank you. How do you maximize synergies between the 7 businesses in the group?

Well, as I have explained, our business model relies on them being independent to a very significant extent and having the ability to make decisions quickly and close to the customer. So we're not like a large international defense prime contractor where there is a big strategic organization in the headquarters that sort of puts the building blocks of businesses together to create vertically integrated offerings to customers. However, we do see many opportunities for our businesses to work together, and we'll do that when it's economically to the benefit of the group as a whole. And we encourage information sharing and knowledge about the other businesses through quarterly meetings of all of the managing directors, what we call our Group Executive Meeting. And we also have forums for discussion of particular opportunities as well. And that's manifested itself in a number of examples recently. So we have our business SEA is providing some vital contributions to ELAC SONAR's provision of submarine sonars for the Italian Navy. A very important area is CHESS, which is providing the trainable base for the ancillary product, which SEA is supplying to the Royal Navy. So we do see plenty of opportunities for synergy, and we'll always take those when they're economically beneficial. But by the same token, I'm quite happy for our businesses to cooperate with external partners if that's more likely to result in the kind of product that our customers need.

Thank you. A nice answer there, Andy. Thank you for that. There's been very little acquisition on the -- action -- sorry, on the acquisition front for a long time, now ITS and EM Solutions in 12 months. Is this due to a refocus or the right opportunities coming along?

I think perhaps the London bus effect is the best answer to that question. We have a very selective approach to acquisitions. So we are not -- I mean, there are plenty of businesses out there that have an acquisition machine, and they will -- a key performance indicator is doing a certain number in a year, and that is not us. We are determined to focus on value and growth prospects. And in relation to both of the acquisitions that you've mentioned, we saw those as being very beneficial. As far as the number of prospects is concerned, I think it's fair to say we've probably seen an increase in that over the last few years, and that's not untypical of a situation where we see hardening demand and people see opportunities perhaps founders see opportunities to exit from the business that they might not have had before. But as you have noted, that hasn't resulted in a flood of acquisitions. It's really all about quality.

So the further question that comes up there is, does that mean that you have a larger acquisition pipeline as a result of those?

I certainly don't want to comment about the possibility of acquisitions in a particular time scale. But what I would say is we're certainly seeing plenty of opportunity.

Perfect. Thank you. Next question is, what is the company's market share within the industry?

Well, that's a very hard one to answer because there's a lot of different ways of answering it. And we have really -- quite a wide variety of technology-based products, each of which has got a slightly different position in relation to its competitors. I think what I'd say there is that because of our business model and because of the agility of our businesses, I think that in many cases, it gives us an edge over our competitors. And I mean, you can take plenty of examples of that, but one that I would draw attention to would be ELAC SONAR's winning of the project to supply sonar systems for the new Italian submarines. As I mentioned, the contract is now with over EUR 100 million. It's very substantial. And believe me, these are very substantial pieces of equipment. And that was won against some of the world's best companies, Atlas Elektronik and Thales to name but 2. And I think that's, if you like, a good justification of the business model that we have and our ability to win against seemingly larger and more powerful competitors. And that's replicated in many places across the business. Sorry not to be able to give a quantitative answer, but it's simply too wide a front to do that on.

Next question is similar in a way, but it's how does the company's performance compare to its competitors?

Well, of course, we're most interested in our own performance. But I think if you look at that compared to our competitors and if you look at total shareholder return, you will see we've really done pretty well over the last few years. Over the last 3 years, our profit has grown with a compound annual growth rate of over 14%. What's interesting is that our order book has grown at a much faster rate than that. And I think that, that's a very strong indicator of future growth prospects. And I think that, that compares very well to a lot of peer and competitor defense companies on the market of overseas.

Thank you. And -- what are the key drivers for the growth of the company -- what are the key drivers for growth the company in the current market?

Well, as I've indicated, demand growth is coming from 2 main sources, one being the conflict in Ukraine and the tension across Europe, which is not going to stop, by the way, if the conflict in Ukraine comes to a conclusion, temporary or permanent. And the other is the increased assertiveness and indeed aggressiveness of China in the Indo-Pacific region. But beyond that, there are specific areas of the market, which are growing faster than others. And as I've indicated, electronic warfare, battlefield intelligence secure, robust communications and counter drone capabilities are 4 good examples of that. The business model that we have enables us to focus our technology efforts on where the growth potential is most exciting. And that's what we've done, and that's what's been able to drive the growth that I just described.

Next question, how reliable are the orders in your order book?

We have a very prudent -- that's not a word accountants is supposed to use anymore, but we have a very prudent approach to recognizing orders. So we do not recognize, for example, agreements with customers that they might or might not buy something from us over a period of time as an order. To appear in our GBP 0.5 billion order book, something actually has to be contracted and committed. And for it to come out of the order book again, there would have to be a contractual change agreed between customer and supplier. So yes, it's pretty solid.

And next question, please, can you tell us more about the major projects you referenced in Portugal?