XAR - Good Moves At Leonardo DRS Catches Attention

Summary

• Leonardo DRS is new to the NASDAQ after merging with RADA Electronics. Shares opened at $11.50 and climbed to $13.46.
• The company operates in the essential defense and homeland security industry specializing in communications and radar systems selling to rather than competing with big contractors building ships and tanks.
• We expect better revenue and EPS and take a bullish position on the small niche company over the long term.

Leonardo DRS, Inc. (DRS) is a small defense and homeland security, tech-product contractor. We expect the company to announce earnings on February 8, '23. The report is the company's first since the all-stock merger with Israel-based RADA Electronic Industries near the close of last year and listing on the NASDAQ. DRS shares opened at $11.50.

We are bullish on the stock; the company sells into an essential industry without competing against the behemoths dominating defense and homeland security. The combined revenue and earnings from Leonardo DRS and RADA make the stock a potential growth opportunity for retail value investors. Greater revenue and earnings-per-share are the consensus.

Good Momentum

The share price climbed from $11.50 to a 52-week high of $13.46. This is a confirmation of good moves made by management. The stock was already steaming ahead, recording a 466.8% gain over the last 5 years. The price popped another +8.3% YTD.

Short interest (there are 2.43M outstanding shares) is a moderate ~4.9%. The Beta rating is 0.94. If revenue and earnings are below expectations, as is frequently the case, the stock might dip, making Leonardo DRS an even more lucrative investment over the long term.

50 Years of Success

Leonardo DRS is celebrating its 50th year in business. The company's market cap is up to $3.51B. It was sold to an Italian defense contractor over time.

Leonardo DRS specializes in naval systems, ground combat mission command, and network computing. In the aerospace sphere, Leonardo DRS designs and sells global satellite communications and network infrastructure, avionics systems, intelligence gathering, and security systems. The company builds power systems and electro-optical/infrared systems for commercial customers.

As a subsidiary of Leonardo DRS, RADA designs and produces proprietary radar solutions and legacy avionics systems for customers worldwide. The company sells mini-tactical radars for active military protection, counter-drone applications, critical infrastructure protection, and border surveillance.

The CEO told Virginia Business:

We do communications, we do electronics, we do sensors, so we're independent of platform choices. We're platform-agnostic. That's important [because it] means we can go different directions with different platforms…between a new platform, or an upgrade of an old platform.

The company has 35 subsidiaries stretching across the U. S., Canada, Germany, and now Israel. The merger with RADA follows Leonardo DRS' $450M sale of its satellite communications subsidiary in August '22.

Leonardo DRS was a solely owned subsidiary of publicly traded Italian defense manufacturer Leonardo S.p.a. (FINMY). FINMY shares hovered under $4 until governments approved the merger of RADA Electronics and Leonardo DRS. After DRS began trading, Leonardo S.p.a.'s shares closed as of this writing at $5.15; its market cap jumped from $3B to $6B today. RADA was a public company listed on the NASDAQ. The sale made RADA the transactional partner Leonardo DRS used to raise its public listing, valuation, and profile.

Good Potential

A smattering of analysts covers Leonardo DRS. The consensus is the stock is a buying opportunity. A few hedge funds bought shares through the end of FY '22. Funds increased their holdings by 37.8K shares last quarter. We cannot identify any trend in corporate insider trading, but expect to have that information in another two quarters.

117 institutions own 12% of the shares valued at $410M; public corporations own almost 72%; the public owns 16.5% according to NASDAQ.com; as of January 30, '23, institutional stockholders' activities were:

Demand for Product

Defense and homeland security are essential in developed and developing countries. Products are in constant demand. The war in Ukraine is heating up. The U. S. is replacing weapons it shipped to Ukraine from Poland and Israel warehouses. The recent attack on an Iranian military drone factory, warnings from a U. S. general predicting war with China, and substantial arms trade in Africa make investing in these contractors a potentially profitable investment; we imagine Leonardo DRS Inc. will grow just from the spill-over to smaller niche players. Here is an image of equipment Leonardo DRS contributes to military hardware, courtesy of the company:

Two research firms issued "outperform" and "buy" ratings, respectively. Another indicator confirming our bullish position per DRS is the SPDR S&P Aerospace & Defense ETF ( XAR ). Shares rose 31.6% over 5 years, 5.67% last year, including 6% YTD. The Seeking Alpha Quant Rating is a Buy, though this is not a recommendation, coupled with a Factor Grade A for momentum.

Fly-By Numbers

Last year's Q4 EPS for Leonardo DRS was $0.1. We forecast its Q4 '22 EPS will likely be about $0.35. Income growth over the last 5 years topped 50%. Net income margin was last reported at a healthy 14.78% and ROE at 25.95%. Debt is +$500M, cash is $63M and its Enterprise Value is $3.86B. We will know more at the release of the next report.

Takeaway

We are bullish on Leonardo DRS for three reasons. First, they sell into a growth industry. Emerging nation-states spend a lion's share of their budgets on military equipment. Second, two of three priorities in the next U. S. DoD budget are upgrading the Navy and Air Force; that bodes well for Leonardo DRS Inc.

The third reason relates to the company's ties to Italy's and Israel's defense establishments. The first budget prepared by the new right-wing prime minister Giorgia Meloni's government has a procurement outlay of around €8.25B ($8.7B) for 2023, slightly higher than 2022. Israel's defense spending focuses on high-tech defense and offensive weapons. The budget is always on the rise. Threats of war with Iran is likely to generate more business for RADA.

On the downside, Leonardo DRS does not share a lot of information. Its website is paltry, sans up-to-date information about customers, sales, targets, and goals. Few press releases are issued. There is no reference we can find about the merger with RADA Electronics on the company website. After all, RADA got Leonardo DRS its placement on the NASDAQ. There do not seem to be any RADA officers among the top management team. How is the merger going organically? Some discussion about assets and expertise Leonardo DRS will bring to RADA and future directions might be helpful to investors and analysts.

The stock will be more attractive to retail value investors if the PE slips from its 22.29 closer to 20, a reasonable number for a small niche player in a huge industry. Keep in mind that good things come in small packages.

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