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MS International (LSE:MSI) has four business. In September the directors published a profit warning which we need to take seriously. It stated, “It is most disappointing to report, though not surprising, that the Company is not immune to the negative impact of the widespread global economic uncertainty. As reported in the last Chairman’s results statement, these are proving to be ‘interesting times’. Across the four divisions we are seeing a progressive reduction in demand for both our products and services…given this reduction in demand, in the short term we expect a substantial weakening in the Company’s results”.
From this announcement we can anticipate much reduced profits in the next year, perhaps all the way down to zero. This is what prompted an immediate crash in the share price, falling over 20%.
It would seem, that all the businesses are suffering, but the defence business is picked out for special mention because the UK government procurement system is cock-eyed.
Defence
The Defence division mostly makes naval guns and sells to 16 countries, with 250 systems already in place. It also services those guns – a source of on-going revenue in times of order drought.
Defence division numbers
| £m | Revenue | Operating profit | Capex | Assets minus liabilities | Operating profit/net assets | ||||
| 2011 | 32.6 | 5.4 | 0.0 | 16.6 | 33% | ||||
| 2012 | 29.9 | 6.6 | 0.1 | 15.8 | 42% | ||||
| 2013 | 28.0 | 2.9 | 0.1 | 16.7 | 17% | ||||
| 2014 | 19.4 | 0.9 | 0.1 | 14.4 | 6% | ||||
| 2015 | 17.0 | -0.2 | 0.1 | 14.1 | -1% | ||||
| 2016 | 21.9 | 2.0 | 0.2 | 14.2 | 14% | ||||
| 2017 | 20.8 | 1.8 | 0.2 | 12.2 | 15% | ||||
| 2018 | 21.9 | 2.6 | 0.02 | 21.5 | 12% | ||||
| 2019 | 26.7 | 2.8 | 0.07 | 10.4 | 27% | ||||
| Average 18% |
The strategy pursued for the Defence division is to keep ahead of the competition through R&D spend thereby building on its current pre-eminence and to grow the non-UK market “so that we can effectively counter the varied current constraints on UK MoD decisions regarding future requirements and expenditure.” (2019 Report).
And this approach is bearing fruit: “It is pleasing to report that once again, international sales accounted for the major component of revenue as we reap the benefits of our considerable investment in a substantial number of new products aimed specifically at the global market.” (2019 Report)
A weakness remains in that one customer (UK’s MoD?) accounted for £10.9m of the £26.7m revenue in 2019 – a greater spread of revenue sources would be more reassuring. Clearly, we can expect a continued lumpiness in the profits.
The September profit warning seems to imply that this year’s Defence profits might be eliminated (but I might be misinterpreting it):
“…significant slowdown and delays in the awarding of UK defence related contracts, following requests for tender submissions. Delays in anticipated contract awards, by their very nature, engender costly uncertainty and concern particularly when being the only genuinely qualified potential supplier. Unfortunately, responding to customer invitations to submit a comprehensive tender and then failing to award a contract is becoming an increasingly frustrating feature of our domestic defence business.”
Short term frustration and loss of profits in the current period, yes, but note the comment “the only genuinely qualified potential supplier”. An indicator of a strong competitive position, a franchise? The directors have told me directly that no one offers a suitable alternative to MSI’s gun – it is the best (only) in its niche.
Also, note what the Defence division has been doing to broaden its appeal, so it is not dependent on the unpredictable MoD:
“Notwithstanding these challenges, as a highly reputable and innovative SME, we are firmly committed to defending our company position for the long term in this important strategic market. Accordingly, we took great pride in launching at the recent London International Defence Equipment Exhibition a number of new and exciting products, emanating from our ambitious privately funded product development programmes and enhanced international marketing. Pleasingly, the interest and response of both existing and of potentially new customers from around the world, should prove to be very rewarding over time.” (17th September regulatory announcement)
These are Yorkshire engineers who do not prettify or do PR. When they say that they are excited about a pipeline of products, and they have genuine interest from potential customers I take it very seriously. There won’t be an immediate uplift in sales from either the new products or the MoD, thus short-term profits will be down, but eventually things will look a lot better
“In summary, given this reduction in demand, in the short term we expect a substantial weakening in the Company’s results, although for the future we firmly believe that we are well placed with additional strong business positions and a very healthy maintained cash position.” (17th September Regulatory announcement)
Some profit warning – bursting with long-term optimism!
Defence division – Industry analysis
In this section I’m asking if this industry is likely to achieve high rates of return on capital employed. Much of what follows must be tentative given the dearth of solid data.
- Threat of entry to the industry? The costs of entry are relatively low in terms of factory set-up costs. However, the extant players have some name recognition and relationships with defence departments and militaries around the world. They also have some degree of differentiation through R&D and manufacturing excellence. Experience and knowledge of the industry may provide some protection, but it is not insuperable. Navies that have already installed guns may encounter switching costs if they were to move to a different gun manufacturer. The path dependent special………………To read more subscribe to my premium newsletter Deep Value Shares – click here http://newsletters.advfn.com/deepvalueshares/subscribe-1
