RNMBF - Rheinmetall Promises 'The Best Year Ever' In 2022

• Rheinmetall is a large supplier to the automotive and defense sectors in Germany.
• Germany will increase its defense budget and Rheinmetall should benefit.
• The H1 results were uninspiring, but the second semester is generally more important for Rheinmetall.
• An EPS of 10 EUR could be quite realistic.

Introduction

As it has been almost four years since I last discussed Rheinmetall ( OTCPK:RNMBF ) ( OTCPK:RNMBY ) here on Seeking Alpha, I feel an update is warranted and the recent release of the Q2 and H1 results provides an excellent starting point for an updated analysis. I would also like to refer you to Wolf Report's recent coverage on Rheinmetall clearly explaining the updated thesis and how the increased budget for the German military forces will have a direct positive benefit for Rheinmetall.

The US listing of Rheinmetall is pretty illiquid, so I would strongly recommend to trade in Rheinmetall on the Deutsche Boerse where it is trading with RHM as ticker symbol . The current market capitalization is approximately 7.3B EUR (using a net share count of 43.4M shares), and the average daily volume in Germany is approximately a quarter of a million shares per day.

The results in the first semester were very satisfying

The first half of this year was pretty good for Rheinmetall as the company reported an increased revenue and operating income at a higher margin. That's quite encouraging in a world where margins are continuously under pressure. More importantly, Rheinmetall continues to see an increasing order intake in both the civilian and defense business.

That's great news as this once again confirms Rheinmetall is in an excellent position to benefit of the increased and increasing defense spending in Germany. The invasion of Ukraine by Russia has sent a shockwave through Europe and most countries are increasing their budgets to (finally) start meeting the [soft] NATO requirement to spend 2% of the GDP on defense.

Not a whole lot has changed if you would have been in a coma for the past four years: the outlook for the automotive industry remains uncertain but the defense spending is improving and accelerating and that pretty much is the same picture as in 2018 .

In the first semester of this year, Rheinmetall reported a total revenue of 2.67B EUR and after including the changes in inventories, the total 'operating performance' came in at 2.9B EUR. As expected, the higher revenue wasn't really resulting in a much better performance as the COGS increased by about 7.5% and the staff-related expenses also increased by about 10%. With a reported EBIT of 185M EUR we shouldn't be too unhappy though, especially when you see the 'other net financial expense' came in at 40M EUR versus just 11M EUR in the first semester of last year.

The net income came in at 134M EUR of which 6M EUR was related to discontinued operations and about 29M EUR of the total reported net income was attributable to non-controlling interests. This means the EPS was approximately 2.42 EUR per share. This includes about 0.14 EUR in net attributable income from discontinued operations resulting in an EPS of 2.28 EUR generated by the continuing operations.

Looking at the cash flow result, Rheinmetall reported a negative operating cash flow of 557M EUR. However, this was predominantly caused by a 589M EUR investment in the working capital position as well as a 131M EUR change in receivables and prepaid items. Adjusting the result for these elements, the adjusted operating cash flow was a positive 163M EUR. That's still not great but keep in mind this includes about 62M EUR related to pension provisions and retirement obligations.

Using the 163M EUR as starting point and after deducting the 100M EUR in capital expenditures, Rheinmetall's free cash flow was approximately 63M EUR. And if we would add back the pension-related items, the free cash flow would have been close to 125M EUR which is pretty much in line with the reported net income (on a consolidated basis).

This doesn't sound too appealing, nor from an EPS point of view nor from a free cash flow point of view. But keep in mind Rheinmetall's performance tends to be rather heavily weighted towards the second half of the year and I expect to see the same thing this year. Considering Rheinmetall is still guiding for a 15% revenue increase this year, we can basically expect the H2 revenue to be at least 20% higher than the total revenue in the first half of the year. In fact, barring unforeseen circumstances, the full-year EPS will likely come in close to 10 EUR per share if the H2 expectations indeed do play out.

Let's also not forget the order intake from the German army will likely accelerate in the next few quarters.

Investment thesis

I missed my opportunity in 2018 when Rheinmetall was trading at less than 80 EUR and then I missed a second opportunity during the COVID crisis in 2020 when Rheinmetall's share price dipped to less than 50 EUR per share. I don't think Rheinmetall is expensive now and that impression was confirmed during the Q2 conference call when the CEO mentioned 2022 'will be the best year in the history of Rheinmetall'. A bold statement and considering the anticipated order intake numbers for the next 24 months, it's likely 2023 and 2024 could be more record-breaking years.

I haven't decided yet if I should establish a long position. Perhaps I should consider writing put options as for instance the P120 for December (which is almost 30% below the current share price) is approximately 3.75 EUR while the P140 (a 17% discount to the current share price) has an option premium of approximately 7.50. Attractive premiums and even if I don't get assigned to buy the shares at those low levels I'd still walk away with some sort of return.

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