FINMF - Leonardo: Solid Numbers But Weaker 2023 Guidance

2023-03-10 23:21:25 ET

Summary

• Leonardo's 2022 profits grew by 58%; however, the dividend remains at €0.14 per share.
• Solid order book that represents a production capacity for the next 2.5 years.
• Lower debt, higher FCF generation, and still at the bottom quartile in peers' valuation. Our overweight target is then confirmed.

In our last publication, we reported how " Leonardo's (FINMF) stock was up by just 28% in 2022 versus a plus 63% compared to the European defense peers. This was mainly due to consensus 2022-2023 earnings per share estimates amid group supply chain concerns, high inflation, and slower order growth relative to rivals ". Despite an initial concern with an equal weight valuation (positively) titled Back To Profitable Growth , we decided to increase our target price to €10.5 per share ( Now a Buy ). It was a good call and since mid-December, the company is up by almost 30% and reached our estimates.

Q4 results

Yesterday, the Italian defense player reported solid numbers and today we are taking the time to review its financial information, but also to update our readers on the company's main highlights.

1. In 2022, looking at the financials, there is an initial recovery of the Aerostructures sector, which reduced the cash absorption to €296 million compared to €339 million recorded in 2021. According to the CEO, the division will be back at breakeven in 2025;
2. The company reduced its debt by approximately €100 million thanks to its FCF generation and Leonardo DRS disposals that compensated for the 25.1% acquisition of Hensoldt and RADA consolidation. The group also repaid debts of approximately $500 million, with the repurchase of dollar bonds maturing in 2039 and 2040;
3. Revenue growth was more stable with a plus +4.7%; however, the gross margin significantly improved and as a consequence, the company's EBIT and net income reached €1.2 billion (+15%) and 697 million (+18.7%) respectively;

4. Key to emphasize is the increase in Leonardo's 2022 order book to €17.3 billion with a plus 21%. The order book is now valued approximately at €37.5 billion which is equivalent to about 2.5 years of production.

Positive take

In recent weeks, Leonardo signed two agreements , one with the Israeli Innovation Authority and the other with Ramot Tel Aviv University. The company's goal is to strengthen its leadership position in the defense world with Israel which has been able to create an ecosystem of innovation that has become the engine of the country's growth and contributes to 15.3% of the country's GDP.

Separately, Boeing (BA) and Airbus (EADSF) are reportedly competing for a massive order from Air India, which is estimated to amount to around 500 aircraft; the deal is expected to include the Airbus A350 and the Boeing 787 and 777X. Leonardo has a strong involvement in the wide-body Boeing 787. According to the Wall Street Journal, wide-body aircraft demand is on the rise due to the travel demand rebound. This positive news is also confirmed by the recent Nippon Airways release which confirmed that it will increase its Boeing 787 fleet to " 100 or more " aircraft in 2030 from the current level of around 50 in 2019. Higher long-haul traffic translates into more production of wide-body aircraft and this is a clear positive trend for Leonardo.

NATO is also pressing Italy on defense GDP investments. In 2014, NATO leaders had agreed to spend at least 2% of GDP on defense within a decade, but last year Mario Draghi's government has postponed the deadline to 2028. According to NATO data, several states are already exceeding 2% (the UK and Poland); with 2022 Italy's prediction on defense spending at 1.54% of GDP. This might suggest that Italy could invest another €10 billion in the next two years to reach the target (and Leonardo will definitely benefit from this scenario).

Conclusion and Valuation

Guidance for 2023, Leonardo expects orders for around €17 billion, revenues in the €15/€15.6 billion range, and a cash flow of 600 million. Forecasted net group debt of around €2.6 billion. And the 2026 outlook, there is an estimated cumulative order of €90 billion, compared to the previous guidance of €80 billion. In numbers, this implied an average annual growth rate in the mid-single-digit range (4-5%), and on the marginality, there is a positive CAGR estimate at the EBITDA level in the high single-digit range.

Profitability is growing and net debt is falling, these are Leonardo's main ingredients; however, projections remain slightly timid for 2023, with revenues growing by 2%-6% (compared to a +5% in 2021 and +4% in 2022). While many investors are betting on the defense sector, in the context of higher international spending, consensus expectations were likely to be higher. Still, on the negative side, Leonardo left unchanged its dividend, which remains confirmed at €0.14 per share as it was in 2021. Within the sector, the company is currently trading in the bottom P/E quartile and is offering an FCF of 13% by 2025. Therefore, despite the lower guidance (for now) and a significant decrease in debt (positive for its equity value basis), on an FCF yield estimate, we decided to increase our target price from €10.5 to €12 per share.

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