Share of the week: Profit from adversity

The sun finally came out this week and hundreds of smiling City workers fought over the tiny patch of grass outside our offices. And it seems most traders used Friday's US non-farm payrolls as an excuse to sit things out this week, leaving the FTSE 350 to drift 2% lower. But not all stocks were doomed.

Electra Private Equity's half-year results triggered a rally to record highs, and investors responded positively to trading updates from JD Wetherspoon and financial security firm NCC Group. More interesting, however, is £1.9 billion British aerospace and defence company Cobham.

Under pressure from dwindling western defence spending, budgets have been increasing over the last couple of years, but Cobham cannot catch a break and the shares have slumped by 40% over the last six months.

They've crashed by nearly a quarter since 26 April, when the group delivered an emergency £500 million rights issue after warning that profit was seriously behind expectations. The group generated just £15 million profit in the first quarter compared to £50 million in the first three months of 2015.

"For the full year, the scale of the order book and the impact of the cost reduction programme which we are currently implementing, will mean that the profit shortfall is expected to be limited to about £15 million," said chief executive Bob Murphy.

It's the Wireless division that's causing issues, with shipment delays leading to fines. Cobham is coming up against headwinds in its commercial "fly-in, fly-out" business and costs in the Advanced Electronics Solutions space are rising. Although the rest of the group is trading in line with expectations, it's going to take a lot to turn this year around.

With slow earnings unable to sustain necessary ongoing development investment, Cobham came dangerously close to its net debt to cash profit covenant ratio of 3.5 times.

Crucially, the rights issue will bring Cobham's tested covenant ratio back to 2 times when tested at the end of June, and will support its operations, cost-cutting schemes and investments for the remainder of the year.

It also allows the company to maintain 2015's total dividend pay-out of £126 million this year.

Crashing through its 200p technical support level and the bearish trend line seen on the chart above, Cobham's share price collapsed to an 11-year low of 146p. But, since Wednesday, the shares have bounced over 12%.

Deutsche Bank has cut its earnings forecasts by 19% to 15.81p in 2016 and slashed its target price from 235p to 185p. Despite these significant downgrades, the shares currently price this risk in and the City broker has upgraded its rating from 'sell' to 'hold'.

This year's performance is still very much in the air - a lot of execution risk surrounds Deutsche Bank's forecasts, but more concerning is the potential for Mergers and Acquisitions. After such a poor share price performance, some bigger firms will undoubtedly be considering Cobham as a take-over target.

Although this will provide short-term respite for the shares, integration will be difficult with such a complex portfolio, warns Deutsche.

"Despite the 40% fall in the shares year-to-date, we do not believe the most recent share price decline represents a buying opportunity - with residual risks remaining, in our view, over hitting revised FY 2016 guidance," said analyst Benjamin Fidler.

There is a lot of work ahead to get Cobham firing back on all cylinders, but investors will hope this is a turning point.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.