Leonardo DRS: Expect Its Fast, Profitable Growth To Continue

seekingalpha11-08

Leonardo DRS is rated a Strong Buy due to defense spending tailwinds, improving margins, and expected double-digit EPS growth in 2025 and 2026.The company specializes in advanced sensing, network ...

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BergmannD/E+ via Getty Images  Investment thesis Growth stock Leonardo DRS, Inc.  has had a year of rapidly rising share prices, a whopping 79.59%. And that obviously leads to the question: Will it continue to grow profitably or will this uptrend fade out?","collect":0,"end_time":0,"defaultTopTitle":"seekingalpha.com","property":[],"viewcount":null,"language":"en","relate_stocks":{"DRS":"Leonardo DRS, Inc.","BK4187":"航天航空与国防"},"translate_title":"Leonardo DRS：预计其快速、盈利增长将继续","themeId":null,"isJumpTheme":false,"ttsUrl":null,"symbols_score_info":{"DRS":0.9},"content_text":"Leonardo DRS is rated a Strong Buy due to defense spending tailwinds, improving margins, and expected double-digit EPS growth in 2025 and 2026.The company specializes in advanced sensing, network computing, and propulsion technologies, with 80% of its revenue from the U.S. Defense Department.Despite competitive challenges, Leonardo's sole-source contracts and intellectual property provide a narrow to medium moat.Risks include fixed-price contracts, limited public ownership influence, and high competition, but strong earnings growth potential supports a bullish outlook.   BergmannD/E+ via Getty Images  Investment thesis Growth stock Leonardo DRS, Inc. (NASDAQ:DRS) has had a year of rapidly rising share prices, a whopping 79.59%. And that obviously leads to the question: Will it continue to grow profitably or will this uptrend fade out? I argue that higher prices and capital gains will continue because of defense spending tailwinds, improving margins, and the double-digit EPS growth expected in 2025 and 2026. My one-year price target is $42.44, a 19.65% increase over the November 6 closing price, and I rate it a Strong Buy. About Leonardo The defense contractor describes itself this way in its 10-K for 2023, “We specialize in the design, development and manufacture of advanced sensing, network computing, force protection and electric power and propulsion technologies and solutions.” DRS markets photos (Q3 earnings call presentation) It has eight business units, organized into two segments: Advanced Sensing and Computing, and Integrated Mission Systems. Advanced Sensing and Computing “designs, develops and manufactures sensing and network computing technology that enables real-time situational awareness required for enhanced operational decision-making and execution by our customers.” Integrated Mission Systems “designs, develops, manufactures and integrates power conversion, control and distribution systems, ship propulsion systems, motors and variable frequency drives, force protection systems, and transportation and logistics systems for the U.S. military and allied defense customers.” Its markets are the U.S. Defense Department, which represented about 80% of total revenue in 2023, while the other 20% came mainly from the defense departments of allied countries. Leonardo also reported in the 10-K that most of its contracts are firm-fixed price, that it considers its intellectual property valuable to its operations, and that it has patents that have grown out of its research and development. And although its business is not seasonal, significant portions of its revenue, profit, and cash flows come to its fourth quarter. That’s mainly because of the federal government’s budgeting cycle. The firm has what it calls “Our Ultimate Majority Stockholder”, which is Leonardo S.p.A., a prominent Italian Aerospace, Defense, and Security company. In 2022, Leonardo S.p.A. organized an all-stock merger that combined Leonardo DRS with RADA Electronic Industries Ltd., an Israeli provider of small-form tactical radar. This Seeking Alpha ownership summary indicates Leonardo S.p.A. owns all or most of the Corporations [Public] holding: DRS ownership table (Seeking Alpha) Obviously, public ownership, which includes individual shareholders, is a tiny minority. At the close on November 6, its shares traded at $35.47, and it had a market cap of $8.74 billion. Competition and competitive advantages Leonardo describes its markets as highly competitive, and advises that it competes with a wide variety of companies, including large defense contractors with more resources available for research and development. It lists its main competitive criteria as “product performance, cost, overall value, delivery schedule, embedded positions, past performance, innovation and reputation.” I see that price is not a significant factor, which is understandable in the high-tech business. Its main competitors, according to MarketBeat, include Nokia Oyj (NOK), STMicroelectronics (STM), Hubbell (HUBB), ASE Technology (ASX), GlobalFoundries (GFS), United Microelectronics (UMC), Ubiquiti (UI), Flex (FLEX), Astera Labs (ALAB), and Universal Display (OLED). This chart of normalized net income margins, comparing Leonardo with the first three names on the competitors’ list, show it doing poorly (orange line): DRS net income margins chart (Seeking Alpha) Although it does not compare well with its competitors, Leonardo still earns a reasonable net margin. Combining that with its patents and established position with the federal government, I would assess its moat as narrow to medium. Latest earnings report Third-quarter results were released on October 30, and beat EPS estimates by $0.05 and revenue estimates by $36.56 million. This slide, from the Q3 investor presentation, shows robust progress on multiple metrics: DRS Q3-2024 highlights (company presentation) In the earnings release, Chairman and CEO Bill Lynn said, “We delivered strong third quarter results, highlighted by robust bookings, mid-teens organic revenue growth, increases to all of our key profit metrics and healthy free cash flow generation.” In the Q3 earnings call with analysts, he noted, “Demand for our naval network computing, electric power and propulsion, force protection, and advanced infrared sensing technologies were key contributors to our $1.1 billion of bookings for Q3.” To put the earnings report into context, Q3 continues the rapid growth on the top and bottom lines we’ve seen in recent quarters. Between the ends of December 2018 and Q3-2024, revenue increased by 36.26%. Growth in net income was even more dramatic, from minus $10 million at the end of 2018 and $198 million [TTM] at the end of September 2024. That loss in 2018 was the only one; Leonardo has been profitable every quarter and year since. Leonardo’s growth prospects The company provided its outlook for full-year 2024 in the charts below, along with its positioning for growth, in this slide from the Q3 investment presentation: DRS Q3-2024 highlights slide (Q3 presentation) A couple of points: First, it reports that more than 60% of its revenue comes from sole-source contracts. Second, it is being proactive about improving its margins, which would make the company more effective and efficient at turning revenue into net income and cash flow. The eight analysts who follow Leonardo expect this year’s revenue to be 12.81% higher than last year’s. They then see year-over-year revenue growth of 7.29% in 2025 and 6.20% in 2026. Their earnings targets are more ambitious than their revenue targets: DRS EPS estimates table (Seeking Alpha) In comparing revenue and EPS estimates, we see the importance of margin improvements. Earnings are rising at roughly twice the rate of revenues, indicating the analysts think the company will make good on becoming more productive. This, in part, is what CEO Lynn had in mind when he referred to “strong operational execution” on the earnings call. Externally, the geopolitical environment is favorable. Lynn observed on the earnings call, “we believe that the robust threat environment will require higher and prolonged U.S. and allied defense investment. Our diverse and platform-agnostic portfolio remains well-positioned to meet our customers’ most challenging mission needs.” Growth is also being driven by the merger with RADA in 2022. Lynn said, “our strategic rationale for acquiring RADA nearly two years ago continues to be validated and the business has performed well. The urgency and imperative to protect people and platforms from proliferated airborne threats has only increased. Today, effective air defense is being achieved through a greater quantity of capable and distributed tactical radars versus the traditional more centralized model.” A new area of growth sees it integrating AI into its sensing solutions. Overall, the company has reason to be optimistic about future growth, and profitable growth. Valuation This 10-year chart shows how the share price has risen, and especially since the merger with RADA in June 2022: DRS 10-year price chart (Seeking Alpha) Because of the rapid rise over the past two years, the stock gets bad grades for valuation, as shown in this excerpt from the Seeking Alpha valuation page for Leonardo: DRS valuation table (Seeking Alpha) Still, those EPS estimates suggest there are more capital gains ahead (the company does not pay a dividend). Analysts expect 2024 earnings to grow 24.21% over those of 2023; they also expect year-over-year growth of 16.13% for 2025 and 14.78% for 2026. Using those estimates, I will set a one-year price target. With one quarter left in 2025, I’ll multiply 24.21% by 25%, which equals 6.05%. The target also includes three quarters of 2025, so we will multiply 18.13% by 75%, for a product of 13.60%. Adding 6.05% and 13.60% gives us a sum of 19.65%. Adding 19.65% to the November 6 closing price of $35.47 leads to a one-year target of $42.44. That’s significantly higher than the Wall Street analysts’ average price target of $35.00, a 1.33% decline. I consider my target more realistic. First, the Leonardo share price rose 7.35% on November 6 alone, so an increase of 19.65% is not out outside the range of possibilities. Second, as we saw above, the company has a significant tailwind, a history of growing its revenue and earnings, and is steadily improving its margins. I rate Leonardo a Strong Buy, as do four of the eight Wall Street analysts (there is also one Buy and three Holds). The Quant system rates it a Hold, and there have been no other Seeking Alpha ratings in the past 90 days. Risk factors I am making a bullish case for Leonardo, but future net income and earnings may not justify higher share prices. Similarly, management has an optimistic take (and perhaps an optimistic bias) that may be disproved through future events that lead to disappointing fundamentals. The company operates mainly on fixed-price contracts. They may lead to cases where expenses and costs are higher than income. A mere 1.44% of the company’s shares are owned by public investors, with almost three quarters of the shares controlled by the parent company. Because of this imbalance, public shareholders may not have any influence over future board decisions. Leonardo operates in an intensively competitive industry, and failure to keep up with its competitors could damage its reputation and/or financial status. If competitors are more innovative, it could lose portions of its business. As a military contractor, cyber criminals may target it. Losses of secret documents or data could prove very expensive. Similarly, it notes in its 10-K that it is likely at greater risk of terrorism than other companies. Conclusion  Leonardo DRS deserves a Strong Buy rating for its potential earnings growth. The company not only has defense spending tailwinds that will produce higher revenue, but is also becoming more productive. The latter means it will realize more net income and earnings from each dollar of revenue.  And while it competes in an intensively competitive industry, over 60% of its current revenue comes from sole-sourced contracts, it has valuable intellectual property, and its growing earnings produce higher bottom-line results that can be invested in new growth.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"1","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.1","shortVersion":"4.29.1","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2481920031"}