With expanding defense budgets, the defense industry has been in focus for well over a year now, prompting a sharp increase in defense stock prices, making it more difficult to uncover names that are undervalued. I have been expanding my coverage significantly over the past two years, and the newest name in my coverage is Elbit Systems. In this report, I will be discussing the company’s most recent results as well as its valuation.
What Does Elbit Systems Do?
Elbit Systems Ltd. is an international technology company engaged in a range of programs across the world. The Company develops and supplies a portfolio of airborne, land and naval systems and products for defense, homeland security and commercial aviation applications. Its systems and products are installed on new platforms, and it also performs platform modernization programs. In addition, it provides a range of support services. The Company’s activities include military aircraft and helicopter systems; helmet mounted systems; commercial aviation systems and aerostructures; unmanned aircraft and unmanned surface vessels; land vehicle systems; command, control, communications, computer and intelligence (C4I) systems; intelligence and cyber systems; electro-optic and countermeasures systems; electronic warfare and signal intelligence systems, and various commercial activities. It operates primarily in the defense and homeland security arenas.
The company has the following reporting segments:
- C4I and Cyber providing command, control, communications, computers, intelligence and cyber solutions.
- ISTAR and EW providing intelligence, surveillance, target acquisition, and reconnaissance and electronic warfare solutions.
- Land, which provides Land System solutions.
- ESA, which is the American subsidiary of Elbit Systems.
Unfortunately, Elbit Systems does not provide any breakdown of revenues between commercial and defense sales. As a result, we don’t know how much the company can lean on commercial growth. It is, however, known that the company has commercial exposure on some Boeing (BA) programs and is involved in the development of AerSale’s (ASLE) wearable Enhanced Flight Vision System or EFVS. Elbit content on the device includes ClearVision™ multi-spectral camera, SkyLens™ HWD and other system components manufactured by Universal Avionics, a subsidiary of Israeli manufacturer Elbit Systems.
Elbit System Financial Results
For the second quarter, revenues rose 11.5% to $1.45 billion with a gross profit margin of 25.6% compared to 26% in the same quarter last year. Driven by Training & Simulation sales in Europe, aerospace sales increased 19% to $487 million, while C4I and Cyber sales were stable at $168.7 million. Electronic Warfare sales in Europe drove the ISTAR and EW segment sales up by 21% to $292.7 million, with modest growth of 3% to $294.1 million in Land Systems sales. Elbit Systems of America saw its revenues increase by 7% to $355.3 million.
Operating income was $101.6 million, down from $115.1 million in the comparable period last year. The costs for marketing and selling increased by roughly $19 million, which already explains the gap in the apparent reduction in operating income. Furthermore, Elbit Systems booked capital gains from the sale of a building in Israel and shares in a subsidiary last year. Adjusting for this, the profits rose from $103.3 million to $112.2 million or 8.6% pointing at lower margins driving by the higher selling expenses. Furthermore, adjusted net income declined to $76.9 million from $93.4 million a year earlier, which was driven by higher interest rates.
Overall, the top line growth provided strong evidence of an attractive product portfolio that is currently high in demand, coupled with easing supply chain issues.
What I Don’t Like About Elbit Systems
What I am not particularly thrilled about with Elbit Systems is the lack of guidance. For a company with $5.5 billion in revenues, I would have expected that at least some guidance could be provided, but that is simply not how Elbit reports. In the same way, the company is not providing a breakdown of revenues between commercial and defense, which are two distinctly different end-markets each with different growth rates and growth drivers.
During the second quarter, the adjusted operating margins also declined slightly and with easing supply chain issues I would have expected better cost absorption. For the six-months period, the margin still shows a 1.2 percentage point increase and net income margin is stable. With easing supply chain issues and higher sales, I hoped to see stronger margin expansion, but right now the higher interest expenses are putting a damper on net income margin expansion.
Is Elbit Systems Stock A Buy, Sell Or Hold?
While defense companies are hot, I can only conclude that Elbit Systems is not. Just like many defense companies, the stock climbed after the invasion of Ukraine by Russia before giving a significant portion of those gains back. I added the forecast figures as well as the balance sheet for Elbit Systems into the evoX Financial Analytics tool to parse any upside, and the result for Elbit is rather cumbersome. Against the median EV/EBITDA, the company is significantly overvalued.
Elbit Systems, seems to be one of the companies for which investors are now justifying an enterprise-to-EBITDA multiple that is in line with the industry. The bad news, however, is that even at this expanded multiple Elbit Systems has no upside. In fact, the stock is overvalued with 2023 earnings in mind and I could somewhat understand that at this point investors are looking to pull the 2024 financial forecasts into the stock price, but the current stock price already includes that. So, there is little to no fundamentally driven upside to Elbit Systems stock the way I see it now, and I would mark it a Hold, but barely. To me, Elbit Systems stock is in the low-end of Hold range, meaning that from a valuation perspective it could become a Sell if it misses targets or expectations.
Conclusion: Elbit Systems Stock Is Not Attractive
Elbit Systems stock has gained since the war in Ukraine, but just like many companies the stock was valued too richly and fell back and even at current prices the stock provides little to no upside. Furthermore, the quarterly results did show margin contraction despite easing supply chain issues. Elbit System might be a stock that offers value for the long-term, but there is no reason to buy the stock at the current prices, even more so given that customer payments have been delayed driving up the borrowings with no clear sight on when these trade receivables will be filled. I would expect it to be by year-end, but the current projections do not provide any evidence that the short-term bank credit and loans will indeed be of short-term nature.