FINMY - Leonardo: Double-Digit Growth Since My First 'Strong Buy' But There's Still Room To Go

2023-09-29 09:39:09 ET

Summary

• Leonardo S.p.a.'s stock has surged by +75% in just 10 months since December 2022.
• The company's first-half fiscal 2023 results show a substantial increase in new orders and successful debt reduction.
• Leonardo is building competitive advantages through collaborations and technological advancements, positioning it for future growth.

Since my first article on Leonardo S.p.a. (FINMF) in December 2022, in which I gave it a "Strong Buy" rating, the company has delivered an astonishing performance, surging by +75% in just 10 months.

During this period, several noteworthy developments occurred, as I highlighted in the March 2023 update, where I reaffirmed my "Strong Buy" rating. This article serves as a continuation of the analysis initiated in 2022, providing an update on significant events that have transpired since then (here are the links to the two previous articles: Leonardo: Significantly Undervalued But Poised To Grow , Leonardo: A Great Long-Term Pick ).

While Leonardo's stock price has exceeded my 2023 price target, I still believe the company has further growth potential. Not only it is presently undervalued in comparison to its European competitors, but it also possesses the momentum to reach new highs. Nonetheless, considering all factors, especially the current stock price, and despite my continued optimism regarding the company's prospects, I have decided to revise my rating for Leonardo from "Strong Buy" to "Buy." This adjustment is due to the diminished safety margin that initially justified the higher rating.

Starting with 1H23 Results

I'd like to start by discussing Leonardo's first-half fiscal 2023 results, emphasizing two notable points that have particularly caught my attention.

Firstly, it's remarkable to note that new orders have surged by a substantial 18.9% in comparison to 2022, rising from €7,310 million to €8,691 million. This impressive performance not only exceeded expectations but was also in line with my previous projections outlined in the last article . It is no surprise that this growth has been fueled, in part, by the increased defense spending across Europe and Italy's ambitious defense redevelopment plan, with Leonardo as a key supplier. I foresee this upward trend continuing, especially considering that countries like Poland, a recipient of Leonardo's AW149 multirole helicopters , have decided to further boost their defense budgets.

The second noteworthy point revolves around Leonardo's highly successful debt reduction strategy. This strategy was previously highlighted in the 2023 guidance, and during the first half of the year, the company managed to reduce its Net Debt by an impressive €1,156 million, marking a substantial 24.1% reduction from €4,793 million in 1H22 to €3,637 million in 1H23.

From my perspective, these achievements not only underscore Leonardo's strong position within the European defense sector, but also showcase the company's capability at satisfying its shareholders while maintaining robust control over its balance sheet and expenses.

For those who wish to delve deeper into the latest Key Performance Indicators, please find them attached below, along with a reference to the latest press release from which I gathered the data above.

Leonardo: Pioneering the Future with Technological Advancements

Before delving into my evaluation, I'd like to share two noteworthy pieces of news regarding Leonardo, regarding its central role both from a technological and strategic point of view. These updates, in my view, are crucial when assessing whether a company represents a strong investment proposition from a fundamental perspective, often referred to as "competitive advantages." Leonardo appears to be building several of these advantages.

On September 12, Leonardo announced:

Defense industry leaders in the UK, Japan and Italy have agreed a trilateral Collaboration Agreement to deliver the concept phase requirements of a next generation combat aircraft for the Global Combat Air Programme ('GCAP').

The agreement between BAE Systems ("UK"), Mitsubishi Heavy Industries (Japan) and Leonardo S.p.a. (Italy) reflects positive momentum and strong trilateral cooperation...

(Source: Leonardo Press Release )

It doesn't take much to recognize the tremendous growth potential that lies ahead for Leonardo, particularly in the forthcoming years.

Another piece of news I'd like to highlight is an in-depth analysis featured in the newspaper La Repubblica , focusing on the "virtual factory of helicopters." This was subsequently shared by Leonardo on its dedicated investor page:

The digital twin is the most advanced point of digitalization in the industrial sector… a virtual platform which, thanks to the convergence of sensors, supercomputing, cloud and broadband, allows continuous monitoring and validation of the performance and security standards required of the real platform. A potentially replicable use to study the behavior of any system under different operating conditions: be it an airplane, a satellite, an infrastructure or an entire industrial plant.

The processed data is a "goldmine" of information on everything that revolves around the helicopter, expanding its potential and capabilities at every stage. With obvious benefits in terms of savings on design and testing times and production costs

(Source: Leonardo Press Release)

Since Leonardo's page reported the content only in Italian, what you see is my translation of the content, however I've also included the link to the page.

All this added together, from my point of view, shows what an extraordinary company Leonardo is, and, more importantly, the promising trajectory it is poised to follow in the years ahead.

Valuation

Regarding the valuation, in my previous article, I had set the target price for 2023 at €12.85. Currently, the price stands at €13.65, indicating that Leonardo is trading at a premium compared to my fair value as calculated using the Discounted Cash Flow Model (you can find the initial December 2022 valuation in the tables below).

However, it's important to consider several factors at this moment. Firstly, the half-yearly results have exceeded expectations, with a significant increase in orders. Additionally, inflation has not eroded margins, in line with my earlier expectations. Furthermore, the upward revision of defense spending has infused great optimism about the company's future.

In my evaluation regarding the Best Case scenario for 2023 I wrote:

I also considered an optimistic case where the fair value is €14.60.

I have assumed no impact on the company's margins (due to inflation) in 2023 and a further increase in military spending over the next 10 years.

For these reasons, since the conditions for the Best Case Scenario of my December 2022 model have been respected, I have set my new price target at €14.60. This indicates that with current conditions, Leonardo has a possible upside of 7%.

Moreover, using an alternative valuation method based on the NTM TEV/EBITDA multiple, it's clear that Leonardo is currently undervalued compared to its competitors. With a multiple of 6.5x, Leonardo's valuation is lower than Airbus (10.01x) (EADSF), BAE Systems (10.13x) (BAESY), Thales (9.63x) (THLEF), and Safran (13.06x) (SAFRF).

To sum up

In conclusion, Leonardo remains an outstanding company with robust growth drivers and a strong strategic position in the European defense sector. Taking into account various factors, such as its competitive advantages, optimism about the sector's future, and the company's current momentum, I believe that Leonardo still has the potential to achieve new highs. However, given the reduced margin of safety, I adjust the rating to "Buy."

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