Share tips: A frontline cyber-defence stock

By Paul Hill Dec 20, 2011

Paul Hill

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The defence sector has lagged the FTSE 100 by 10% in 2011 due to fears about government spending cuts. Yet investors are ignoring the opportunity offered by cyber-warfare. This is a $13.8bn global market expanding at 8%-10% per year, aimed at protecting countries against espionage, breaches in state secrets and attacks on critical infrastructure.

This is where Ultra Electronics comes in. Its two largest divisions, battlefield IT (36% of sales) and sonar (20%), are at the cutting-edge of military support for ground, air and naval troops around the world. However, the real interest here is its cyber operation. It has experience in high-grade cryptography, network security and ID management. Last week it spent $115m on two US acquisitions to bolster its presence in surveillance, intelligence gathering and counter-terrorism. All told, cyber now accounts for 20% of the group.

North America provides 49% of the group’s business, while 29% comes from Britain, and the rest from mainland Europe (8%), the Middle East and Asia (14%). Along with governments, customers include BAE Systems, Boeing, EADS, Lockheed Martin, Raytheon, Rolls-Royce and Thales. The chief executive, Rakesh Sharma, said in November that profits would rise, despite demand declining for its sonobuoys (tubes dropped by aircraft to eavesdrop on submarines).

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That’s because its portfolio of 140 or so different niche products acts as an excellent diversifier in the event of a longer-than-expected slowdown. There’s also plenty of scope to make money from its extensive research and development. For example, in July, Ultra bagged a £207m contract to install IT systems at all of Oman’s airports. That pushed its order book up to a record £1bn as at the end of June.

Ultra Electronics (LSE: ULE), rated a BUY by Liberum Capital

Ultra Electronics share price 

For the full year the City is predicting turnover and under- lying earnings per share (EPS) of £730m and 119p respectively, rising to £790m and 127p in 2012. I rate the stock on a 12 times earnings before interest, tax and amortisation (EBITA) multiple. After adjusting for the £77m pension deficit and £10m in net debt, that delivers a fair value of £19.50 a share. Ultra’s expertise should allow it to expand faster than its peers, and possibly even become a takeover candidate for a bigger contractor. Broker Liberum Capital has a target price of £20, with preliminary results out on 27 February.

Rating: BUY at £15.00 

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