Bottom Line: FR keeps flying in strong defence niche

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RECORD profits from the aerospace engineer FR Group yesterday showed the danger of investment generalisations, of looking at the big picture and assuming individual companies will follow industry trends.

This approach, which meant the City recently rated FR's earnings only half as highly as the rest of the market's, goes something like this. The defence industry has been in decline since the Soviet threat imploded, the civil aerospace business is on its knees with hundreds of planes under wraps in the deserts of California - ergo profits from companies with a big exposure to these sectors will be under pressure.

True, but only up to a point. FR has been shrugging off recession and the cold war thaw for years now. There has not been a huge amount of growth over the past five years but not many companies with 65 per cent of their sales to defence-related customers can boast flat earnings over that period and a well-covered, regularly growing dividend.

The payout in 1992 was 8 per cent higher at 7.2p, met comfortably out of earnings per share 7 per cent better at 21.5p.

FR's success lies in its strength in resilient niches and in products that make tighter defence budgets work harder. One of these, a kit used to convert VC-10 transport planes into tanker aircraft for in-flight refuelling, gives the armed services what they like to call 'force multiplication'.

FR secured orders for five more VC-10 conversions last year to add to the 13 it already had. Work on those will stretch into 1996, maintaining the forward order book at a comforting pounds 235m.

FR also provides the Navy with training services, including simulated air attacks that teach seamen to tell the difference between friend and foe on their radar screens and how to communicate with other ships. The Gulf war underlined the importance of getting it right and this sort of spending is likely to be the last to be cut.

The Royal Navy is in the vanguard of a worldwide drive to contract out this sort of work and FR recently signed up with the French navy for similar services. Overseas earnings now account for nearly half of FR's turnover.

The other key to maintaining earnings during testing times has been a tight grip on costs. Pre-tax profits improved from pounds 21.4m to pounds 23.3m on sales 9 per cent better at pounds 182.8m partly thanks to a dip in administrative expenses. Sales from the manufacturing companies rose a tenth despite a 4 per cent reduction in the workforce.

With receptive customers and the lid on costs, FR could make pounds 25m this year and pounds 27m in 1994. The market started to appreciate FR's attractions last September when the shares bottomed out at 164p on a prospective p/e of 8. Since then they have jumped by 60 per cent to 174p but, on 12 times this year's expected earnings, are still at a sizeable and unjustified discount to the rest of the market.