Ultra Electronics (LON:ULE) pre-close trading statement certainly contains reasons for optimism, especially better than expected order development. However, the continuing issues at Herley have led to a reduction of up to £6m in operating profit expectations for the group as a whole in FY18. The problems are no longer attributable solely to the larger than anticipated number of development contracts won, but clearly indicate unexpectedly high costs. The impact reduces FY18 EPS expectations by 6.7%, but should be contained to this year, with still good prospects for the production phases. Our fair value remains relatively unchanged at 1,811p from 1,816p previously.
Herley self-funded development cost increases
The company has indicated that the FY18 operating profit for the group will be some £4–6m below market expectations, as a result of the cost overruns on development contracts at Herley in the Communications & Security division. Historically, issues here have included work on the US Navy Surface Electronic Warfare Improvement Program (SEWIP) and an Electronic Warfare contract for the F-15 aircraft platform. It appears now that the continued additional cost is at least partly due to changes in scope, some of which may be recoverable from the customer, but negotiations on such issues tend to be protracted. We have reduced our forecast for the current year by 6.7% at the pre-tax and earnings levels, largely due to the contract overruns, but also reflecting higher net debt and thus interest. We expect the additional costs to be contained in FY18, but the interest increase reduces our FY19 EPS estimate by 1.3% from 115.9p to 114.4p. We have increased our end 2018 net debt estimate by £35m to reflect Sparton costs, increased working capital and reduced earnings.
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