Barclays downgrades Ultra Electronics on margin concerns

Barclays downgraded Ultra Electronics on Thursday as it foresees material margin compression in the current year and called into question the quality of earnings in recent years.

A squeeze of 200 basis points of margin are anticipated out to the 2020 financial year as the defence contractor feels the full impact of IFRS 15 accounting standards and consequently lower provision releases, together with a lack of new accretive acquisition activity.

"These factors are exacerbated by mix effect, execution and pricing pressure," Barclays analyst Charlotte Keyworth said.

Analysing Ultra's accounting practices over the past five years showed underlying profits tended to include low-quality income items but exclude "one-off" costs. Acquisitions have "disappointed" Keyworth calculating that impairment charges represented 17% of purchase consideration and more than 90% of earn-out targets failed to be achieved.

She also highlighted increased risk around results for 2018's results, due in early March, "given it represents an important opportunity for the new CEO (now in situ for six months) to report findings and reset expectations", while also raising concerns about the US Department of Justice's proposed antitrust investigation into the sonobuoy joint venture between Ultra and Sparton.

The analyst downgraded the shares to 'underweight' from 'equal weight' and slashed the price target to 1,120p from 1,460p.