If you’ve tried investing ethically over the past few years, chances are you’ve avoided defense, just as you’ve avoided cigarettes, gambling, and possibly even alcohol.
But what happens when a so-called “spit stick” starts arming the freedom fighters? Should investors drastically change their minds?
Defense companies have risen in value as Russia continues its attack on Ukraine.
Tense: World threat levels are increasing and nations are increasing their defense budgets
World threat levels have risen, nations are increasing their defense spending and the EU is rushing to arm Ukrainian soldiers. Suddenly, we’re reminded of what the word “defense” really means, and we wonder if defense stocks even have a place in more of our portfolios.
This could mark a re-rating for a sector that has fallen out of favor for some time as investors poured money into green funds and defense companies were weeded out of many “environmentally, socially and governance compliant portfolios”.
There are already signs that the tide is turning. Swiss bank SEB has just lifted some of its restrictions on investing in defense companies.
It will continue to block any company making so-called “controversial weapons” like cluster bombs, but that gives it far more leeway to invest in defense. Other investment companies are likely to follow suit. JP Morgan Chase’s David Perry cautiously notes that defense is a “complex issue when it comes to ESG investing.”
“More investors may accept that ‘defense’ is required to maintain peace and democracy, leading to a re-evaluation,” he notes.
The fact that defense stocks are rising in value will further whet investors’ appetites for an unloved sector. Berenberg analysts Ross Law and George McWhirter point to “conflict-driven demand potential” as the reason defense stocks are now attractive.
“Valuations across the sector remain compelling given the improving prospects for rising defense budgets,” the company said in its latest statement.
Midas mentioned BAE Systems in last week’s column with a £6.53 tip. It has since risen to £6.92. There are other stocks defense fans might want to consider as well. You can see one here.
As NATO countries, including Germany, increase their defense budgets, Chemring is well positioned to benefit from higher spending.
The company makes everything from sensors for electronic warfare to so-called countermeasures – flares and decoys to protect platforms and ships from missile threats.
Chemring has sought to break away from military roots and focus on broader cybersecurity products for everyone, with analysts particularly excited about its US-based Roke security division.
But even the more traditional businesses will see increased interest in the coming months if global tensions remain high.
The company’s shareholders’ statement, released this week, provided reassuring reading, with management saying that year-to-date results will come in slightly above consensus analyst expectations. These calculations will have been made before the recent flare-up, so it is likely that there will be more demand.
Many analysts are positive about Chemring. Peel Hunt, which buys the stock, believes that Roke’s cybersecurity practice will come to the fore as fears of hacking rise, while Berenberg’s Law and McWhirter believe the company has one of the highest demands due to heightened threats near-term becomes conflict in the region, both because of the sectors in which it operates, including cybersecurity, and because of its presence in continental Europe.
In its most recent letter, Berenberg also highlighted the relatively good value of the company.
As of this week, it had lost just 14 times revenue due to a series of problems including an unresolved Serious Fraud Office investigation into money laundering allegations and an investigation into a chemical explosion on Salisbury Plain that killed one person.
Arrangements have been made for both, but there is a chance more will be needed.
Midas Verdict: Looking back is a wonderful thing. Chemring was very cheap until defense was flavor of the month. After this week’s rally, shares are trading at a price-to-earnings multiple of 19, making them a less compelling prospect than trading at 14 times earnings. But at the weekly close of £3.29 they are still trading below Peel Hunt’s £3.60 and Berenberg’s £3.55 targets.
That may be the price we must pay for a company that seems to have reinvented itself for a war waged both on the ground and in cyberspace.
Given that Chemring is in the right place at exactly the right time, it pays to buy Friday on price weakness like Fall.
Traded on: main market Ticker: CHG Contact: chemring.com or 01794 463401
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