LLAP - Rocket Lab: The Shining Star

2023-08-09 12:03:47 ET

Summary

• Rocket Lab's Q2 earnings and Q3 2023 guidance show promising financial projections and causing us to shift our perspective on the company's current valuation.
• The company achieved remarkable milestones in Q2, including successful launches and deployment of satellites.
• Rocket Lab's strategic positioning and widening moat in the space industry make it a strong buy with many avenues for potential growth.

Rocket Lab's (RKLB) recent financial trajectory suggests a shift in the company's valuation dynamics. The company's Q2 earnings and Q3 2023 guidance unveils promising financial projections, indicating that it is time for us to reexamine some of our earlier assumptions and models concerning Rocket Lab. The margin and revenue improvements as well as milestone progress and a widening moat for Electron causes us to regrade Rocket Lab as a Strong Buy.

Q2 Recap

Rocket Lab's Q2 2023 witnessed remarkable achievements across various verticals. The period was characterized by three successful Electron launches, deployment of 17 spacecraft with Rocket Lab components, and near finalization of the acquisition of assets from the Virgin Orbit bankruptcy auction at favorable terms. Management on the recent earnings call highlight the massive value that this acquisition is going to give Rocket Lab, especially on the development timeline and costs associated with the Neutron development.

In addition to the acquisition benefits, Rocket Lab was also able to improve their gross margins much faster than we anticipated. While growing revenue by 11.6% QoQ Rocket Lab was able to cut costs by 6%! Having this level of margin improvement prior to production reuse of Electron is massive and shows the maturity of the business and provides a stark contrast to others in the space .

With three Electron launches providing an assumed $23 Million of the $62 Million (37%) of revenue it is also important to discuss the main driver of revenue which is the Space Systems side of the business. This side of the business continues to perform well with an estimated revenue of $39 Million vs $35.3 Million Q1 23 this 10.4% jump in revenue is only at the beginning of the ramp up for this side of the business with much of the revenue recognition from their large contract likely to start hitting in Q4 of this year.

A Glimpse into Q3 2023

Not only did Rocket Lab have a great Q2 but their projections for the third quarter of 2023 are compelling. The company expects:

• Revenue to range between $73 million and $77 million.
• Launch Services revenue to be around $30 million.
• Space Systems revenue to fall between $43 million to $47 million.
• GAAP Gross Margins to lie between 21% to 23%, with Non-GAAP Gross Margins between 28% to 30%.
• GAAP Operating Expenses to range from $51 million to $53 million and Non-GAAP Operating Expenses between $38 million to $40 million.
• A net Expected Interest Expense of $0.5 million.
• An Adjusted EBITDA loss of $10 million to $14 million.

What this shows is an expected 4 launches and a continued improvement and elevated Gross Margins. While the company isn't Net Income Profitable yet and likely won't be in the short term considering the Neutron development the margin improvements are starting to form a trend toward slowing the cash burn of the company. Based off of the mid points of their guidance we expect Revenue of $75 Million, 22% Gross Margins and OPEX of $52 Million which brings our estimates of cash burn to roughly $34 Million for the quarter vs $46 Million at the beginning of the year. With revenue recognition and Electron reusable improvements in the back half of the year we expect to see this cash burn fluctuate around this level considering there are large CAPEX purchases for Neutron down the road. With that said being able to subsidize their R&D with a Gross Margin positive business is a unique advantage for them, especially when compared with some of their peers such as LLAP and ASTR .

Strategic Positioning and Moat Widening

Rocket Lab's narrative is centered on its manufacturing portfolio and their vertical approach to satellite operations. Making it much more than just a launch provider but with the rest of the small-dedicated launch market falling apart this puts Rocket Lab in a position to not only absorb the volume from those other failing launch providers but also allows them to control pricing as there is minimal competition. While they still need to maintain price awareness vs ride share programs they are in a position to possible raise rates while simultaneously lowering costs with their reusability initiatives. During the recent earnings call Peter Beck reaffirmed his confidence of the timeline of reusable Electron Rockets. While margins are likely to improve for the launch business we imagine most of that margin growth will come from cost reductions instead of launch price increases as Rocket Lab prefers strategies of volume and partnerships rather than monopoly pricing.

In addition to this, the HASTE market continues to be larger than we initially anticipated with another HASTE launch being booked. As we imagine most of these launches are for experimentation, we picture a scenario where more and more flights are booked with Rocket Lab to test the emerging capabilities in the hypersonic's space. While they could not state to much about a pipeline for HASTE launches due to their classified nature. We imagine that this market will continue to grow with full government support .

Risks

The space industry is characterized by its high-risk nature. Launch failures, though rare, can result in significant financial setbacks and affect company reputation. Rocket Lab, while having a near perfect track record, is not immune to such risks and is likely one of their largest risks (even though it is mitigated significantly). We believe other risks that investors should be aware of is that while their net income is improving is not positive and at the current burn rate of $45 Million per quarter and a cash balance of $335 Million they have roughly 7.5 quarters of runway at that current pace. There is a chance that they will have to add more liquidity either through debt issuance or through stock issuance. While unlikely considering the large Space Systems contract, it is important to be aware of this tail risk.

Valuation

Averaging out the latest quarter and their anticipated Q3 performance and then annualizing it, we get the following. Estimated quarterly revenue of $70 million, 22% gross margins, gross profit of $15.4 Million and OPEX of roughly $55 Million per quarter. Annualizing all of these puts them at $280 Million in Revenue, $60 Million in Gross Profit and $220 Million in OPEX. We assume this is the very low estimates considering all the above earnings improvements they plan to make as well as the overall growth of the satellites manufacturing space. With a current EV of $2.86 Billion this places a EV/Sales of this low estimate at ~10X and a EV/GP of 48x which is a 2% EV/GP yield. Keep in mind this does not include any growth and is a low estimate. With the 10 year treasury trading at 4% we imagine over the next 10 years that Rocket Lab will more than beat that earnings yield even when factoring in dilution.

These prices are elevated yet when considered with their growth trajectory and considering these are very low estimates, it doesn't take much for them to start to become more and more of a deal at current prices. With the reuse of Electron, growth of HASTE, dramatic margin improvements, large satellite build contracts, and Neutron there are just too many avenues of growth to not purchase this stock. In addition to all of this, management is not one to doubt, unlike many of their competitors they don't just throw money at problems and hope they disappear. They have a track record of conserving capital and using it effectively and they continue to meet their guidance targets.

Conclusion

Rocket Lab's Q2 performance and their Q3 2023 guidance offers a fresh perspective on the company's valuation and potential growth trajectory. While the inherent risks associated with space launches cannot be ignored, Rocket Lab's strategic moves and ambitious plans position it as a front-runner in the space industry. With a widening moat and many avenues of growth, investors would do well to keep a close eye on this ascending star and have exposure to this excellently managed company.

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