If there is a company to which we should tip our hats, because of its exemplary handling of the weak dollar, it is Elbit Systems Ltd. (Nasdaq: ESLT; TASE: ESLT). Many were ready to write off the defense contractor in the first half of 2008 due to the dollar's freefall, and fears rose over the company's ability to cope with such a weak dollar and strong shekel given that the company's primary market is the US, which accounts for 35% of sales, and that 80% of its employees are in Israel and are paid in shekels.
Yet Elbit Systems, Israel largest non-government defense company, not only maintained its profit margins during 2008, but bettered them. The company recorded a phenomenal achievement by posting an operating profit margin of 8% for the first quarter.
In an environment of a rising shekel-dollar exchange rate, and apparently against all the odds, Elbit Systems overcame its biggest weakness of recent years: its operating profit margin. The weakness was due to the company being, first and foremost, a project-oriented firm, and most of its projects are R&D intensive.
Elbit Systems' involvement in innovative high-tech projects requires a huge investment of resources, both in terms of time and money, in order to meet project milestones, and has an inherent significant impact on the company’s profitability.
If Elbit Systems can achieve such an impressive profit margin at a time when the shekel-dollar exchange rate is at a low point, few words are needed to explain the company's optimism about the rest of the year if the dollar continues to strengthen.
How did Elbit Systems beat such a weak dollar? Primarily through successful financial management and its ability to make effective hedges against the shekel-dollar exchange rate.
Elbit Systems also has a "natural hedge" against the dollar. A fifth of the company's revenue is denominated in shekels through sales to the Ministry of Defense, and another fifth are sales to Europe. Furthermore, most of the company's procurements are made in dollars, and a fifth of the company's workforce works outside of Israel.
The third factor is the heart of my thesis: Elbit Systems has always suffered from the disadvantages of its small size in the global defense industry, especially when taking into account that its immediate competitors include giants such as Boeing Company (NYSE: BA), Thales Group (Euronext: HO), and Rockwell Collins Inc. (NYSE: COL).
It now seems that Elbit Systems has finally beginning to suffer less from its small size that has hitherto characterized it. In 2007, for the first time in its history, the company reached the $2 billion sales threshold, while in 2008, which is supposed to be a boring year since the company has no plans to make any substantial acquisitions, it expects to achieve quite strong organic growth of 30%. (The company completed its takeovers of Elisra Group and Tadiran Communications in 2005-07.)
It is possible that Elbit Systems' current turnover may have reached the point of no return from where its potential to improve its profit margins is now so great that the company can overcome inconvenient exchange rates, just as it has done until now.
Yoav Burgan is the chief analyst at Leader Capital Markets Ltd. (TASE:LDRC)
Published by Globes [online], Israel business news - www.globes-online.com - on August 13, 2008
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