Qinetiq is currently encountering challenges in capitalizing on the broader surge in the defense sector, particularly with issues stemming from its US division, which was expanded through a 2022 acquisition.

A profit warning issued in March led to a nearly 21% drop in the company’s share price, as they cited contract delays in various regions and “challenging” conditions in the United States. This American division resulted from Qinetiq’s $590 million investment in Avantus Federal, a Virginia-based provider of military and intelligence software.

Despite these setbacks, the FTSE 250 defense corporation has experienced a rally in its stock price, particularly after sharing positive preliminary results last week. CEO Steve Wadey announced an extension of a Ministry of Defence contract intended for the testing and training of military personnel.

This contract, renewed for an additional five years and valued at £1.54 billion, contributed to the increase in Qinetiq’s shares following the announcement. The results aligned with earlier guidance, revealing a loss of £185.7 million, while order intake surged by 12% to a record £1.95 billion. As a result, Qinetiq’s shares are edging closer to the 524½p level achieved prior to the profit warning in March, with the stock closing Tuesday at 489p, up 4.9%.

While investors may appreciate the recovery of Qinetiq’s share price, the company still faces significant challenges and is trailing behind its competitors.

The acquisition of Avantus Federal notably doubled Qinetiq’s US business and boosted their overall revenue by approximately 25%. However, a restructuring of its US operations has commenced following the profit warning, with an impairment charge of £140 million recorded for that unit. Analysts anticipate that divestments may be necessary moving forward.

Qinetiq is not alone among London-listed firms grappling with issues post-U.S. investment. Companies like Rentokil and Dr Martens have also faced difficulties after significant acquisitions in the U.S., further highlighting the complexities of recovery in foreign markets.

The planned restructuring of Qinetiq’s US division is expected to conclude later this year, but investors should be prepared for additional updates that may not be favorable, especially under the direction of Tom Vecchiolla, a former US Navy pilot and defense executive appointed to head the American operations in January. Last week’s guidance indicated that sales growth for the upcoming year might dip towards the lower end of an estimated range between 3% and 5%.

Furthermore, the obstacles previously mentioned regarding the US market may persist. Companies are increasingly aware of the considerable challenges posed by the current administration, and while there is an expectation for European governments to boost military spending, the US government seems focused on enhancing efficiencies.

Although there is a valid reason to celebrate the recent contract extension in the UK, this development was largely anticipated, as the contract has been in place since 2003.

Defense firms have gained popularity in recent years due to conflicts in various regions, and the growing valuation of companies like BAE Systems, Chemring Group, and Babcock International suggests strong industry demand.

Executives within the sector are likely strategizing to maximize the benefits of this increased demand, as eventual market cooling is inevitable. Nonetheless, as competitors advance, Qinetiq is focused on its restructuring efforts, which may hinder the company’s ability to keep pace. Analysts at RBC Capital Markets predict a 5% sales growth for Qinetiq in the current financial year, while rivals in the sector are expected to achieve 15% growth.

The recent increase in the shares of this military specialist may present an opportune moment for investors looking to mitigate potential risks associated with Qinetiq’s future.

ADVICE: Sell. REASON: Share price rally offers a potential opportunity to cash out on Qinetiq.