2023-04-08 04:28:47 ET
Summary
- Elbit Systems should benefit from the increased defense spending in Europe and the United States.
- The company is investing in expanding its manufacturing footprint and new technologies.
- I have a hold rating on the stock.
Recent Earnings Performance Review
Elbit Systems (ESLT) recently reported mixed full-year 2022 financial results. The revenue grew by 4.4% to $5.51 bn (vs. the consensus estimate of $5.55 bn). Revenue growth was attributed to strong sales in UAS and anti-submarine warfare, night vision systems, and training and simulation. However, this was partially offset by lower sales of airborne precision-guided munitions and the sale of Ashot Ashkelon to FIMI Opportunity Funds in Q2 2022. Additionally, Elbit Systems' adjusted gross margin declined by 70 basis points year-over-year to 25.5%, primarily due to an unfavorable product mix, wage inflation, and supply chain disruption. The adjusted operating margin also declined by 200 basis points year-over-year to 6.5% due to a lower adjusted gross margin, higher R&D and sales, and higher marketing expenses. R&D expenses accounted for 7.9% of revenue, compared to 7.5% in 2021, while marketing and selling expenses represented 5.9% of revenues, compared to 5.5% in 2021. As a result of the decline in adjusted operating margin, Elbit Systems' adjusted EPS dropped by 27% year-over-year to $6.03.
Growth Outlook
With the announcement of an increased defense budget across most of the European countries and the United States, the company is experiencing increased interest in its products and services. Poland plans to spend about 4% of its GDP on defense in 2023, while Germany plans to increase its defense budget by €10 billion in 2024. In the United States, the National Defense Authorization Act ( NDAA ) allocated $816.7 billion to the Defense Department in December 2022.
Elbit Systems is well-positioned to take advantage of this increased spending, with a strong presence in both the United States and Europe. The company has recently won several contracts from European customers for its products, including artillery and rocket artillery, UAVs, C4I, and armed vehicles. In March 2023, the company secured a $120 million contract to provide unmanned turrets, weapon stations, and mortar systems to the Romanian Armed Forces. In January 2023, it also received a $180 million contract to provide and operate new mission training centers to train the Israeli Air Force’s F15 and F16 aircraft. Additionally, it secured a $170 million contract to operate an advanced armor training center for the Israeli Defense Forces.
Elbit Systems has also been successful in securing contracts through its subsidiary companies. U-TacS, its U.K. subsidiary, was awarded a $410 million , five-year framework contract by the Romanian Ministry of Defense for Watchkeeper X, a tactical unmanned aero system. It also secured a contract from the Australian MoD for Skylark UAVs. The company has also partnered with several large defense companies in Europe. In 2022, it announced a joint venture with KMW, a German armed vehicle manufacturer, to cooperate on the Euro-PULS, the next generation of rocket artillery system for European customers. As a result of this increased demand for its products, Elbit Systems has seen healthy growth in its order backlog levels, which increased by $1.4 billion year-over-year to $15.1 billion in 2022. With its strong positioning in the market, the company is well-positioned to capitalize on the growth opportunities presented by the increase in defense spending.
Backlog chart (Created by DzD Analysis by taking data from ESLT)
Elbit Systems is taking bold steps towards improving its overall performance and meeting the rising demand for its products and services. As part of its transformation program, the company has made significant investments to expand and upgrade its manufacturing capabilities, acquire new vehicles, and construct new production facilities across Europe and the United States. For instance, it is building a new ammunition production site in Ramat Beka, which is expected to be operational by 2024. Elbit Systems has also invested in a new ground combat vehicle assembly and integration center in Charleston, South Carolina, which is expected to be launched in 2023. Moreover, the company is leveraging new technologies to optimize its production processes and enhance efficiency. It has already increased the capacity of its Tel Hai radio production factory in northern Israel by 60%. The company is also implementing a new ERP system that will unify its business processes and replace the 11 different ERP systems it has used in the past. This will streamline its operations, increase efficiency, and enable the company to better manage its supply chain. With these initiatives, Elbit Systems is well-positioned to address the growing demand for its products and services and maintain its leadership position in the global defense industry.
Looking ahead, I believe the company’s revenue growth should continue to benefit from the healthy order backlog levels and new orders. The increased defense budget in European countries as well as in the United States should benefit the company in 2023. Recently, in April 2023, Elbit Systems was awarded a $280 million , three-year contract to supply precision munitions and radio and defense electronics systems to a European country. Overall, I am optimistic about the company’s growth prospects.
Valuation
DCF Valuation (Created by DzD Analysis using Alpha Spread)
In my DCF calculations, I am assuming revenue growth to be in the mid-single digits in 2023 given the healthy order backlog and strong demand in the defense industry. Beyond 2023, I have assumed growth to be in the mid to high-single digits, with a terminal growth rate in the low single digits as the healthy order rate would lead to strong backlog levels beyond 2023. I used a discount rate of 7.55% by using the cost of equity of 8.33% and arrived at a fair value of $153.14 for ESLT.
Using the relative valuation, the stock is currently trading at 26.60x FY23 consensus EPS estimates of $6.56 and 19.80x FY24 consensus EPS estimates of $8.82, which is near its five-year average forward P/E of 21.38x.
Conclusion
To sum up, while Elbit Systems has promising growth potential, I am hesitant to recommend buying the stock at its current premium valuation. There are other defense companies available in the market that are trading at more reasonable prices and offer higher dividend yields than ESLT. As such, I believe investors may be able to find better value elsewhere in the sector.
For further details see:
Elbit Systems: Growth Prospects Could Not Defend The High Valuation