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

Good morning, and welcome to the Cohort plc investor presentation. [Operator Instructions] The company may not be in a position to answer every question received in the meeting itself. However, the company can view all the questions submitted today and publish responses where it's appropriate to do so. Before we begin, I'd like to submit the following poll. And I'd now like to hand you over to Chief Executive, Andy Thomis. Good morning, sir.

Good morning, and thank you very much, Alessandro. Yes, Alessandro mentioned, I'm Andy Thomis. I'm the Chief Executive at Cohort plc. It's great to have this opportunity to talk you through who we are, what we do. And I'll also cover our most recent set of results, which are for the half year that ended on the 31st of October last year. So to begin, who are we and how do we provide value for investors? Cohorts a group of 7 businesses providing technology-based defense products and services to the U.K. and to its allies around the world. We are especially focused on maritime and land systems, though we also do, do some work in the airborne field. The business model aims to maximize the autonomy and independence of our businesses, consistent with good financial and regulatory governance. And that means that decisions can be taken quickly and very importantly, close to the customer. The model maximizes agility and innovation. And at the same time, we support our businesses with a strong balance sheet and the market reach that we have as a wider group. And we have no layer of overhead between our small but experienced headquarters team and the operational management, and that helps give us a real cost advantage as well. We've got a strong record of growth, both organically and by acquisition since we IPO-ed 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'll say more about that in a moment. Our organic growth has accelerated since 2022 when the Russian invasion of Ukraine shocked really NATO, Europe into a step change in defense spending. And of course, we're seeing strong pressure from the new American administration to increase that further now. And other worldwide tensions are also contributing to a strengthening demand picture, which I'll say a little more about in a moment or 2. Another result of the geopolitical position is a strong pipeline of future opportunities, and I'll give some examples of those as well later in the presentation. But the ultimate hard evidence of growing demand is our growing order book. And as you'll see in a few moments, it hit a new record at the end of the first half, and it's had a further significant boost with the EM Solutions acquisition. That acquisition was funded using a combination of our existing cash resources, some bank debt and also support from our investors in the form of a GBP 40 million placing. And the result of that is that we've maintained a very strong balance sheet with low gearing. And that gives our customers confidence in awarding us substantial contracts. And it also allows us to invest in product development and capacity building and potentially in further acquisitions as well. And finally, I should mention our progressive dividend policy. We've grown the dividend every year since our IPO and by 10% in each of the last 3 years. And of course, that's valuable income for our shareholders. But I think just as importantly, it's a signal that we're not just developing interesting technology, but we're also a successful and cash-generative business. Now a word or 2 on our development as a business. As I said, we IPO-ed on AIM in 2006. And since then, we've made a number of acquisitions as well as some divestments to ensure that we remain focused on our core markets. And some of the most important transactions 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 more about each of those businesses in just a moment. So by the end of 2024, we developed into a group of 6 businesses with revenue of more than GBP 200 million 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. And over that period, I should say that we've been very, very mean with issuing a new equity. Apart from employee share schemes, we issued no new shares at all 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 another word then about that acquisition. It's a very significant transaction for us. It will have a big impact on our product range, on our technological capability, our geographical footprint and our financial performance as well. 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, those will be moving across the horizon as the ship potentially rolls and pitches really quite significantly in heavy seas. Demand for satellite communications is growing, particularly for advanced navies like those in Australia and the NATO countries. This is the first time with this acquisition that we've been involved in this technology. And so it gives us access to an important new stream of growing revenue. Over time, the balance of our output as a group has moved more and more towards the maritime market. And this acquisition adds another important family of naval products to our portfolio. And that enables us to offer packages of systems to shipbuilders and integrators, which is an efficient way to offer our products into the market. Very importantly, bringing EM Solutions into the group will have geography-based advantages in both directions. The group's position as a domestic supplier in 3 NATO nations and our strong export relationships around the world will help EM Solutions in markets that have become very important to them. And similarly, for the existing group, Australia's close relations with the U.K. and its growing defense budget make it an increasingly important customer and having a footprint there will greatly enhance our ability to access that market. Now we recently announced that the transaction completed at the end of January, and we're already well into the process of integrating this great new member of the group. So EM Solutions is clearly an exciting development, but I should also let you know a little about our other businesses. We've got 2 reporting divisions, Communications and Intelligence, and Sensors and Effectors. Taking the Communications and Intelligence division first. EID is our Portuguese business, it's based just outside Lisbon, and they focus on communications management for naval surface ships and also communications for land vehicles and deployed army headquarters as well as soldier radios as well. Our business, MASS provides highly specialized services, including electronic warfare operational support, cyber defense and also large-scale simulation-based training for the U.K.'s strategic command. Our business, MCL works with overseas and U.K. partners to supply a wide range of communications and intelligence equipment to the U.K., and that's especially important for urgent operational requirements, which, as you can imagine, there are quite a large number of at the moment. In our other division, Sensors and Effectors, Chess provides optical tracking, surveillance and weapon control systems for land and sea applications. And those are especially important for countering the threat from drones. ELAC SONAR, based in Kiel in Northern Germany, is a world-leading provider of sonars for ships and submarines. And our business SEA provides systems for protecting ships from submarine and missile threats as well as communications for the Royal Navy submarines. And it was SEA that won our largest ever contract last year, valued at GBP 135 million for their product known as Ancilia, which is designed to protect the Royal Navy surface ships against the threat from modern hypersonic anti-ship missiles. And in total, we've got something over 1,500 employees, a very large proportion of whom are highly qualified engineers, scientists and mathematicians. Overall, we offer a complementary and extensive range of technology-based products and services for defense customers worldwide. So that's some background about the business and what we do and how we do it. And now for a bit about how well this has all worked in practice and in particular, in our most recent reporting period. And the summary is that it was a good first half for us, much stronger than the same period in the preceding year. Revenue and operating profit, as you can see, were up materially. And once again, we reported a new record order book. Our prospects are good. We expect to continue that growth into the full year and beyond. It was a good period for new orders, and those are, of course, the best leading indicator for future growth. Order intake significantly exceeded the revenue we recognized. So the total order book had grown to over GBP 540 million at the period end. And that order book covers more than 99%, effectively all of the consensus forecast of our revenue for the year, and it will be generating revenue for us well into the 2030s. Finally, our operating cash flow was very strong, significantly exceeding profit and helping to push up our net cash position to nearly GBP 38 million. And I should emphasize that that's before the placing and the acquisition. And against that positive background, the Board has again increased the interim dividend by more than 10% compared to last year. So a bit more about the roots of the demand for our products and why it is that I say the demand for our products and services is growing. The 2 main driving forces for demand in defense equipment worldwide are the continuing conflict in Ukraine and the influence of growing Chinese assertiveness and indeed aggressiveness from the Indian Ocean to Australasia. And adding to that mix is the deeper instability in the Middle East as well. In Central Europe, the conflict there has driven demand directly as the NATO countries seek to help Ukraine resist the Russian invasion. And also, many of the lessons being learned from Ukraine are particularly relevant to us. So the increasing importance of electronic warfare, the need to counter drones of all kinds, the need for accurate and timely battlefield intelligence have all been emphasized by the conflict in Ukraine. All of those have had a direct positive effect on our orders and prospects. There's been a lot of talk recently with the Trump plan for a ceasefire and hopefully peace in Ukraine. And that's something that we should all welcome if it stops what really is an appalling waste of thousands of lives every week in that conflict. But whether or not that Trump initiative is successful, in the end, we can be confident that there will be a ceasefire in Ukraine. However, absent a complete defeat and occupation of Russia, which would seem to be on the extremely unlikely end of the possible spectrum of outcomes, that will not 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 in Europe. Unfortunately, the days of the 1990s peace dividend are well behind us now. Chinese aggression and investments in its defense forces has also had an impact on our prospects right across the Indo-Pacific region. The AUKUS alliance and the new program to provide nuclear submarines for Australia is one example. But we've also seen strong demand from countries, including Thailand, Indonesia and the Philippines as well really across that region. Japan remains committed to a doubling of its historic level of defense spending up to 2% of its GDP by 2027. And Japan has joined the Anglo-Italian next-generation combat aircraft project. And that bodes well, I think, for the opening up to European suppliers of a market that's historically been dominated by the United States. As well as export markets, we've seen similar effects in our domestic markets. We expect to see the results of the U.K. strategic defense review in the second quarter of the year. But the government has already committed to increasing defense spending to 2.5% of GDP, and there is already talk about the potential for increasing that level of spending further. In Germany, we can see the impact of the step change in defense spending that's taking place, and we're seeing that with increased local orders and opportunities for our German business, ELAC. And even in Portugal, one of the NATO members that still falls short of the 2% target, we saw some long-awaited orders arriving in 2024 and are very optimistic that there are more to come. I should emphasize that we're investing to respond to these changes in demand. We're increasing capacity at our businesses, Chess and SEA, by expanding and reorganizing our facilities. And ELAC will be moving into a brand-new custom-built facility next autumn. And as our revenues continue to grow as a result of this strong demand, we expect to see a gradual improvement in margin as well as our overheads remain relatively constant with growing demand. I mentioned that we continue to see good opportunities beyond the current order book, and I wanted to share a few of them with you. I should say that when producing these slides, we have to move quite quickly as it turns out some of the opportunities I'm about to talk about have, in fact, already been turned into orders. And that's true of the very first bullet point there because at ELAC, we have just received an order for the sonar of the fourth of the 4 new Italian submarine sonar suites that we've been providing. And together with some other changes to that contract, that brings the total value of that program up to over EUR 100 million. And we're now starting discussions about 2 further possible submarines as well as upgrades to some in-service vessels. ELAC is also in discussion with the German Navy about upgrades to anti-submarine sonars on some of its surface ships. And that will be a really important step forward for us with our domestic customer in Germany as most of ELAC's recent orders have been with export customers. EID, the Portuguese business, won some large orders earlier in the year, and they're in discussion with the Portuguese Navy to provide communication systems for its new fleet of 6 offshore patrol vessels, and it sees some promising naval export opportunities through a growing partnership with the Dutch shipyard Damen. And following some initial success in Asia, SEA has multiple opportunities to provide its very specialized KraitSense product, which is a thin line towed array sonar system to export customers. And it's also in discussions 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 the Ancilia product that I mentioned earlier. MCL sees many large potential prospects from urgent operational requirements, most of which are too sensitive to go into any detail about. And MASS, again, sort of overtaken by MASS has actually just won a 2-year extension to its long-term contract to design and run large-scale military exercises for the U.K.'s strategic command, known as JCAST. And it also has a growing relationship with a multinational defense alliance to provide digital secure communications. Our business, Chess sees some really good short-term opportunities for its optical tracking system for countering drones, and it's doing that through a very successful partnership with Rheinmetall, and it's building other partnerships in that area as well. And finally, our newest business, EM Solutions has a really promising list of opportunities in Australia, Europe and East Asia as well. And it's shortly about to begin deliveries covering almost the entirety of the Australian surface fleet and with a lot more in the pipeline. Now these are all prospects rather than firm orders and the value and the timing and the probability of winning all of these is uncertain. But what I hope this does is to paint a picture of the strong demand and opportunity that we're seeing at the moment for the group. Now I've talked in broad terms about markets and opportunities, and this slide shows the tangible results of that demand picture by splitting out the order book as at the 31st of October. And of course, as it was at that particular moment in time, they exclude the contribution from EM Solutions. We're working on the completion accounts for EM Solutions, and we'll make public the substantial contribution to our order book that, that will make at the appropriate moment. But over GBP 540 million, that period-end order book is stronger than ever before. It includes a substantial element that will directly feed into revenue in this current year and the next. But it also includes over GBP 280 million of order cover for 2026, '27 and beyond, guaranteeing a solid flow of revenue well into the next decade. As you can see from the color coding, the larger part of our order book continues to sit with the Sensors and Effectors division. I expect that to remain the case, but the addition of EM Solutions into Communications and Intelligence will redress the balance between the 2 to some extent. 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. And our Chairman, Nick Prest also remains a significant shareholder. But the backbone of our shareholding is a highly reputable list of institutions. And the largest are Schroders, Liontrust and Canaccord Genuity, but other long-term holders include Citi Asset Management, Herald and Unicorn as well. It was really good to see some new institutions coming in at our recent placing, and those included BlackRock, Lazard's and Royal London as well. And that's about what I wanted to say before giving an opportunity for questions. It's been a pleasing period in terms of performance. It sets us up well for the year as a whole. And as I mentioned, the consequence of that is we've been able to increase our interim dividend again by 10%. A point that I've tried to make strongly is that the acquisition of EM Solutions will take Cohort to the next stage of its development. It's a good deal financially. We expect that it will be accretive in the first full year of EM Solutions being part of the group. It will broaden our product range, our technical capacity and our geographical footprint in a very beneficial way. The strong balance sheet that we've retained give us the flexibility to invest in facilities and product development and if more good ones emerge in value-adding acquisitions as well. And finally, I'll draw your attention again to that large order book, that record order book and the excellent pipeline of further opportunities ahead. So thank you again for your attention this morning. If you have any questions, I will do my best to answer them in the next few minutes.

[Operator Instructions] At this point, I'd like to head straight into the Q&A with the first question here, which reads as follows. How do you see increases in NATO spending impacting the Cohort business in the near to medium term?

Well, we do anticipate that there will be increases in spending in NATO Europe. And I would expect that, that will have a positive impact on our opportunities and revenue and profitability in the short to medium term is the quick answer of that, perhaps unsurprisingly. As I mentioned earlier, I think a lot of the things that are -- I mean, growing expenditure is one thing. But specifically, I think the lessons being learned from the conflict in Ukraine is driving expenditure into particular areas where we can provide very good solutions. It's also worth mentioning that our strong maritime capabilities are very well suited to nations that are responding to the aggressiveness and assertiveness of China in the South China Sea and the Indo Pacific more widely. I think our maritime systems like Ancilia that I mentioned like our sonar systems are well suited to navies who are operating in those areas and want to push back against that aggressive posture.

That's great. Turning to the next question. Is the current U.K. defense review having any impact on delivery of the current order book or on expected future orders?

Well, we're waiting expectantly to see the results of the defense review, which I expect will be released at least in part towards the middle of this year and the second quarter of the year. There's lots of gossip about what it might produce. I don't think it would be a surprise if there was a greater focus on the North Atlantic for the U.K.'s defense postum. And that, I think, is something that suits us as a significant provider of equipment into the navy. But we'll have to wait and see what the results of the strategic defense review are. What I would say is it's certainly being led by a very expert team of well-reputed individuals. So my expectation would be that it will be a good piece of work. Is it affecting us at the moment? Well, because the MoD is in the midst of defense review, that has made it pause some decision-making on future projects. That hasn't affected us in a material way. Mostly, it's been in terms of some areas of research and innovation-type funding, which have been put on pause awaiting the results of that review. But as you've seen from our results, let's say, that hasn't really affected our growth trajectory at all.

Next question we've had from an investor. They've asked what the biggest growth opportunities for the company are in the current market environment?

Well, as I've mentioned, we really do see quite a few. I think an increase in NATO spending is a very substantial opportunity. But also, I think some of our products, which are just starting to come into service really offer very good prospects for growth in the coming years. I'll include in that our product Ancilia, the missile defense system for surface ships. SEA's KraitSense product, which is a specialist towed array sonar that's very light. Towed array is like a sort of hose pipe that you pull behind a ship or a submarine. Historically, there have been very large hose pipes indeed weighing well into the tonnes and needing a very large winch to deploy. SEA's product is much lighter and smaller and is suitable for small ships and can give a real anti-submarine capability, the kind of lightweight ship that you see operating typically around the South China Sea. So we see strong demand from that driven by what China is doing in terms of increasing its submarine fleet. I've mentioned Chess' capability for catering drones, which as we've seen in Ukraine is absolutely vital in any modern war fighting or indeed potentially hybrid warfare scenario. And I'd mention the really capable sonar systems, which our business, ELAC Sonar in Kiel is pushing new ground. Those are some examples, I think, of where we see really good growth opportunities. I mentioned satellite communications and EM solutions, too.

That's great. Moving to the next question. How much of next year's revenue is already covered by existing contracts?

Well, just clicking back a few slides, if I can do that. Yes, you can see there, and I can see there, if I take my glasses off, that we were at for -- we were over GBP 130 million for the second half of the -- sorry, for next year at the end of the first half. And that's grown significantly since. I mean, obviously, we'll make our order book public I expect we'll do so when we put out a trading statement in advance of our full year results. But as you can imagine, that's grown significantly since then. And also, it will grow very significantly as a result of EM Solutions becoming part of the group. I can't -- I mean, I don't actually have the precise figures to hand at the moment, say we'll go public with those at the appropriate moment.

The next question, changing gears slightly, moving on to the topic of M&A. The investors ask, what types of businesses or technologies are you most interested in acquiring?

Well, I think our criteria for acquisitions are that, firstly, I mean, it needs to be in defense technology. I mean that's what we know about, that's what we're good at, and that's what we understand. So we're not about to move out of that into other areas. But we'll be looking for technologies, where there is clear access to growth opportunities to growing markets. Defense as a whole is growing at the moment, but it's a large and diverse market. And even when it's growing, some areas are static or in retreat. And even when it's shrinking, which it has done, some areas are in growth. So it's finding those growth niches. And some kind of sustainable competitive advantage is really important. So we're not fighting off multiple other suppliers with very similar products purely on the basis of price. So those are our main criteria. We're particularly interested in maritime systems because I see particular growth opportunities in that area, especially around the Indo Pacific, but also areas where technologies have been accentuated by experience from conflicts in Europe and where European demand is likely to grow. So I'm sorry, that's not a precise answer on specific technologies, but it's kind of hard to do that. We are very selective in our approach to acquisitions, I would say. And we're not like some other companies that will have a performance indicator of doing a certain number per year. We'll only do so when we see the opportunity to add real value for shareholders and potentially for our other businesses as well in doing that.