RNMBF - Rheinmetall Stock: To Buy Or Not To Buy?

2023-08-22 17:02:14 ET

Summary

• Defense stocks have gained attention since the invasion of Ukraine by Russia, but some have valuations ahead of their fundamentals.
• Rheinmetall reported a 6.4% sales growth driven by Vehicle Systems and Weapon and Ammunition segments.
• The company's guidance for 2023 shows strong sales growth expectations, supported by a backlog increase of 17% and international project wins.

Since the invasion of Ukraine by Russia, defense stocks have been the center of attention though some defense stock had and still have valuations that run significantly ahead of their fundamentals. Generally, defense companies expected the first sales from increased defense budgets to be translating to sales in 2024. However, with the increasing support to Ukraine and Germany basically increasing its defense budget overnight, we do see a significant uptick in backlog additions, and we're also seeing some modest growth in sales. In this report, I will briefly have a look at the results and more importantly I will put a price target on Rheinmetall (RNMBF) stock.

A Brief Look At The Rheinmetall Results

The slide above might not be the prettiest one, but it surely captures the essence of the quarter. Sales growth of 6.4% was driven by Vehicle Systems with 22% growth and Weapon and Ammunition with 17.3% growth. The growth in sales in those segments was partially offset by intersegment adjustments and lower revenues in Materials and Trade following the April 2023 cyberattack on the industrial/civil part of the business. This effect also was visible in the operating results and margins which declined from 8.1% to 7.9% with margin declines in the Electronic Solutions, Sensors and Actuators and Materials and Trade offset by better performance in Vehicle Systems and Weapons and Ammunition. Free cash flow declined by €41 million.

So, overall we're seeing strength in the business but with the impact from the cyberattack earlier this year. Furthermore, we should keep in mind that quarterly results cannot be linearized in any way for forward projection since the first half of the year also incorporates higher working capital to support a backloaded profile for the year, or in other words the results in the second half of the year should be significantly better than the first half.

Guidance Shows The Near Term Sales Growth

For 2023, the company is guiding for €1 billion sales growth which is incredibly strong. This growth is driven by 25%-30% sales growth in Vehicle Systems and Weapon and Ammunition, 15% to 20% growth in Electronic. The civil side of the business will see growth despite the cyberattack but in the single digit region. Positioning the company for 17% sales growth in the mid-point with margins expected to be stable.

To this we should add €150 million to €190 million in revenues from the acquisition of ammunition maker EXPAL that closed in July and would bring the sales growth to 20%.

Guidance Supported By Backlog

The good news for Rheinmetall is that the increased guidance for 2023 is not one-off or unsupported. We see that the backlog grew by 17% to more than €30 billion or 4.7x 2022 revenues and 4x 2023 revenues. Some international project wins include a €525 million contract for logistic vehicles for Austria, a €125 million contract for MASS ship protection systems, and over €250 million in contracts to Norway for components for 54 Leopard tanks and 300 trucks.

What is Rheinmetall Stock Worth?

When considering the guidance, one would think that without doubt Rheinmetall is a strong buy. However, the stock gained more than 60% over the past year so the question that should be asked is whether the upward pressure on results already is reflected in the current stock price or not. The difficult thing for Rheinmetall is how are we going to value the company even if we have filled in all information on EBITDA, debt, cash and so forth.

Rheinmetall has a median EV/EBITDA over the past 10 years of 6x. With that in mind, the valuation is significantly stretched and interestingly provides little to no upside until 2025 from fundamental perspective. However, one can wonder how applicable the 6x multiple still is given the expanding defense budgets, the backlog growth for Rheinmetall and the diversification with work on the F-35 and bolstering the ammunition business via the acquisition of EXPAL. So, perhaps this stock should trade in line with the industry, which provides an $86.65 price target and 63% upside. That upside might feel steep adding roughly 10x to the valuation. Whether that multiple expansion will or will not happen remains to be seen. What we do know is that an expansion from 6x to 12.8x already has occurred and while I would not want to extrapolate one could find some support in that expansion to think that Rheinmetall stock could be trading closer to multiples we see for the aerospace and defense industry. Applying the current EV-EBITDA of 12.8x would provide 30% upside and a price target of $69.30. I believe that makes Rheinmetall a buy considering the current state of the defense market and the conservative assumption that further EV/EBITDA multiple expansion will not occur.

Conclusion: Rheinmetall Stock Is A Buy On Sustained Growth

I believe that Rheinmetall stock remains attractive even after surging 60% over the past 12 months. The growth drivers are the expanding defense budgets which currently are translating into a bigger backlog, but we're most likely just at the beginning of higher defense budgets translation into backlog additions and eventually higher sales. Besides that, Rheinmetall is diversifying and expanding which will positively contribute to the company’s earnings and the extraction of value from the current defense landscape which is expected to see significantly higher spendings for years to come. As a result, I rate Rheinmetall stock a buy.

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