Elbit Systems: A Buy in the Middle East War (NASDAQ:ESLT)

In September 2023, we initiated coverage for Elbit Systems Ltd. (NASDAQ: ESLT) with a Hold rating as we believed there was no compelling investment case as the stock rose significantly due to increased demand driven by war in Europe. What I could not have known at the time was that Israel, the birthplace of the Elbit System, would be in armed conflict less than a month later. In this report, I will discuss the latest gains and update my price target and rating.

Elbit Systems: Revenue and earnings grow on flat margins

Second-quarter revenue rose 11.85% to $1.63 billion. Aerospace revenue fell 1.2 percent to $481.2 million. C4I and Cyber ​​revenue increased 11.3% to $187.7 million due to sales of radio systems. ISTAR & EW, which stands for Intelligence, Surveillance, Target Acquisition and Reconnaissance & Electronic Warfare, saw revenue increase 8.9% to $318.8 million, while Land System revenue increased nearly 37% , up to $402.7 million, due to ammunition sales. Elbit Systems of America posted a 10.6% increase in revenue to $392.9 million. So we saw growth in all segments except aerospace. When we look at the revenue and the possibility of a ceasefire in the Middle East, we also have to look at how much revenue has come from Israel. During the second quarter, 27.3% or $444 million of sales were to Israel, up from $244.5 million and 16.8% in the prior year. Excluding sales in Israel, revenue is down 2.2% year-over-year. It is not necessarily the case that in the absence of a conflict in the Middle East there would be a drop in sales, as some sales flow to Israel could be a prioritization of sales at the expense of other geographies, but it is clear that the conflict in the Middle East is the main engine of growth.

Adjusted operating profit rose 13% to $130.5 million on a 10bp expansion in margins to 8%. Uncompensated labor costs related to Swords of Iron War were $3.3 million, up from $2.4 million in the prior quarter.

The backlog grew from $10 billion in 2019 to $21.1 billion by the end of the second quarter. Between 2020 and 2024, the backlog had a compound annual growth rate of 20% and 9% of revenue.

What are the risks for Elbit systems?

The risks for Elbit Systems are a reduction in short-term demand from Israel, which could be the case if there is any form of de-escalation in the region. Similarly, if the conflict increases further, it could increase the demand for Elbit System’s products and services to some extent. In addition, we track uncompensated labor costs. When reserve troops are mobilized, the government of Israel covers a portion of the labor costs. However, in some cases there are excess labor costs that exceed the compensation limit and companies record this as uncompensated labor costs.

Is Elbit Systems a good stock to buy?

To determine multi-year price targets, the Aerospace Forum developed a stock analysis tool that uses a combination of analyst estimates of EBITDA, CapEx and free cash flow, along with the latest balance sheet data, cash flow statements of cash and my debt repayment assumptions. , share buybacks and dividends. Each quarter, we review these assumptions and update accordingly.

For Elbit, we see that analysts now expect 7% higher EBITDA between 2024 and 2026, and the same growth rates are seen for free cash flow. This resulted in a hold rating from hold to buy, with a price target of $236 representing a 19% upside.

Bottom line: Elbit Systems stock is now a buy, but we’re watching the Middle East conflict

Although Elbit Systems derives a significant portion of its revenue streams from outside Israel, a look at the numbers shows that current growth is, unsurprisingly, driven by increased demand for defense equipment and services from Israel. Consequently, while I have a buy rating on the stock, I must note that any easing of the conflict in the Middle East could dampen Elbit’s upside. Currently, the threat level remains high, and although there is talk of a ceasefire, it seems to me that the demand for defense solutions will remain high.