NOC - Hensoldt: A Buy In The Future Of War

2023-05-18 08:58:23 ET

Summary

• Hensoldt is an optronics and sensor specialist with an upside.
• Defense budget expansion offers significant growth ahead for Hensoldt.
• The company already expects billions of euros in added value due to German defense budget expansion.

With demand for defense equipment rising, there are many opportunities in the defense space. However, if you focus solely on the big defense names in the US defense sphere, you might be missing out on investment opportunities as some names such as Northrop Grumman ( NOC ) are not quite valued reasonably while some undercovered defense names are not analyzed for investment. In this report, I will be analyzing Hensoldt (HAGHY), a German defense company.

What Does Hensoldt Do?

Hensoldt AG is a Germany based manufacturer of search, detection, navigation, guidance, aeronautical and nautical systems and instruments. The Company also directly or indirectly acquires, holds, sells and manages stakes in companies involved in the development, manufacture, operation and sale of electrical engineering systems, optronic products and software solutions for military and non-military purposes. Hensoldt used to be part of Airbus (EADSF), but was spun off in 2017 and sold to investment fund KKR and went public in 2020 after which KKR fully divested its 25.1% stake to Leonardo DRS ( DRS ) in 2021.

Normally I try to provide a detailed description of the products that a company offers. However, with Hensoldt I would probably need multiple reports to describe the company's capabilities and products and that might be a good thing as it shows how broad the capabilities are. Putting it as brief as possible, I would refer you to the slide above accompanied with the note that Hensoldt provides optronics, sensors, radars, electronic warfare capabilities for space, air, land and sea-based platforms. The company is continuously expanding its capabilities, and as defense platforms become more and more driven by electronics as well as advanced sensor sets, that bodes well for Hensoldt.

A Look At Hensoldt's Q1 2023 Financial Results

While there is a big tailwind for Defense as expanding budgets will boost defense equipment orders, not many defense companies are getting big orders as the procurement of defense equipment requires scoping of the budget and an evaluation process as well as down-selects and eventual approval from the buying and selling countries.

In the first quarter, the order intake was down around 50%. This was driven by big frigate and communication, command and control contracts last year. This year, the order inflow included orders for the Leopard 2 Main Battle Tank platform from Norway and Sweden. That platform is one of the most advanced offensive platforms that NATO partners are sending to Ukraine. The orders could in some way be related to Ukraine as some orders are also long-term replacement plans that are being accelerated now. Orders that can be more directly linked to Ukraine are orders for the TRS-4D/TRML-4D Radar Family, which is a multi-functional air surveillance and target acquisition radar system that utilizes components from Hensoldt.

For the first quarter, revenues grew by 18% to €338 million driven by Sensor revenues growing by 18.6% reflecting the increased demand for TRS-4D/TRML-4D systems, the PEGASUS airborne electronic signals intelligence system and Eurofighter radars. Optronics revenues grew by 14.1% as investments in the business in South Africa paid off.

Adjusted EBITDA grew by 81.2% to €30 million driven by higher volumes in the sensor business outpacing cost growth while the optronics business saw losses grow to €5 million from €2 million a year earlier. Adjusted EBITDA margins improved from 5 to 9 percent. That is not quite in the 10 to 15 percent range I want to see it, but it should be noted that excluding pass through on annualized level Hensoldt is a 20% margin business. So, I would say that the improvement in adjusted EBITDA is promising for the full year and even more promising when we consider the extremely broad array of products, many of which will see increased demand in the coming years from Germany but also internationally, that Hensoldt AG offers.

Hensoldt Expects Strong Growth With Dividend Growth As A Given

For 2023, Hensoldt expects 7% to 10% revenue growth and margins of around 19%. The medium target shows a growth rate of 10% annually for revenues and higher than 19% adjusted margins and I would say that the defense landscape is there to achieve that. The company also offers a dividend, and while its dividend yield is not quite impressive at less than 1%, the growth prospects for the business potentially allows for building a low yield on costs while stock prices move in line with earnings growth.

Is Hensoldt Stock A Buy?

The above sounds nice but we have to look at whether the stock actually offers reasonable upside. For that I use the interactive valuation tool that I will soon be launching for subscribers of The Aerospace Forum. Using an industry median EV/EBITDA of 15.5x, it would imply that Hensoldt has 25% upside.

Conclusion: Hensoldt Could Be A Rewarding Defense Buy

With the increasing demand for defense equipment and electronics and sensor components getting more and more prominent, I do think that Hensoldt is positioned well to benefit from the German defense budget expansion as well as the global budget expansion. Simultaneously, the company is also expanding its capabilities which will boost the company's already prominent exposure in various areas even more. While the company's dividend yield is not quite attractive, I do believe that as European countries increase defense equipment procurement, Hensoldt is positioned extremely well to grow in the years to come.

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