Elbit Systems conundrum: Rising orders, falling stock

Elbit Systems  credit: Elbit Systems, processing: Tali Bogdanovsky
Elbit Systems credit: Elbit Systems, processing: Tali Bogdanovsky

Despite frequent announcements of large contracts, Elbit Systems' share price is down 6% this year. Analysts: Foreign investors don't want Israeli stocks.

Defense budgets around the world are rising, and defense companies are benefitting from increasing demand for their products. Elbit Systems (TASE: ESLT; Nasdaq: ESLT) too keeps reporting large contracts. Its orders backlog reached a record $17.8 billion at the end of last year, and just this week the company announced contracts worth $760 million for the Israeli Ministry of Defense, the latest of many such announcements in the past few months, with large orders coming from the US, Europe, and Australia.

Nevertheless, while defense sector stocks have risen by some 8% so far this year and by 18.5% over the past twelve months, Elbit’s share is in the doldrums. The share price is down 6.2% for the year to date, at just under $200, which is similar to the price just before the Swords of Iron war broke out in October last year, giving the company a market cap of $8.9 billion. Elbit Systems, headed by Bezhalel Machlis and controlled by Michael (Mikey) Federmann’s Federmann Enterprises (44%), is due to release its first quarter financials next week.

"Foreign investors not keen on Israeli market"

What is the explanation for the stock’s lackluster performance? Two analysts we spoke to mention negative sentiment towards Israeli stocks. "Elbit is an Israeli stock," says Liran Lublin, head of Research at IBI Investment House, "and there are many good Israeli stocks that are underperforming - Bezeq, the banks, Bazan with record results and a declining share price. Foreign investors are not keen on the Israeli market, and Israelis themselves are deciding to look overseas. We are seeing many foreigners exiting the stock, and not enough Israelis buying to halt the slide."

Oppenheimer Israel analyst Omri Efroni adds: "There’s a trend of anti-Israeli sentiment, which can exert a great deal of pressure on foreign investors to sell the stock." He cites the Bank of Nova Scotia, whose asset management company Scotiabank recently sold 40% of its holding in Elbit. According to a filing with the SEC (the US Securities and Exchange Commission), the bank had a 2.5% holding in Elbit at the end of the first quarter, which compares with 4.2% at the end of the previous quarter. This is after it sold shares in the fourth quarter as well. This implies sales of shares to the tune of some $150 million during the first quarter. If the bank still has the same stake today, it is worth $225 million. In Efroni’s view, the bank did not want to be associated with the stock. Bloomberg has reported in the past that the bank has been a target of protests and petitions because of its holding in Elbit.

Efroni says that, besides the pressure on foreign investors, the problem is also low liquidity in the stock on Nasdaq, which depresses it. He believes that at the same time there are institutions that want to invest in defense stocks, because of the high spending on defense in the US and Europe, so that new buyers could come along, but it’s hard to know when that might happen. Oppenheimer gives Elbit an "Outperform" rating with a price target of $256, 28% above market.

According to IBI’s Lublin, another factor negatively impacting Elbit Systems, though to a lesser extent than the general negative sentiment, is its cash flow. "In the end, when you look at the numbers for the past year and going forward, you see impressive growth in the orders backlog and in revenue, and a supportive macro environment, since defense budgets around the world are rising," he says. "Elbit entered this period with a somewhat higher p/e ratio, reflecting market expectations for growth. All that has still not percolated through to the company’s cash flow. The Ministry of Defense paid its debts in the fourth quarter (Elbit previously stated that the Israeli Ministry of Defense had not paid its debts, S. H-V.) but then a cash flow gap opened up again."

Lublin adds that "what interests the market in periods of uncertainty is not just growth, but how much cash flow a company can generate, and here Elbit has further work to do." IBI’s recommendation for Elbit is "Market perform", with a price target of $220, 10.2% above the current share price.

What should we expect in the quarterly financials next week?

Efroni: "I should mainly like to see an improvement in their operating profit margin. On the demand side, there are no worries. We’d like to see the company’s ability to improve stocks and operating profit, and to reduce finance expenses."

Lublin: "I presume that we’ll see in the reports handsome growth on the revenue line, and further good growth in the orders backlog - we’ve seen the contracts that have been signed. Finance expenses will be high, on a similar level to previous quarters, because of the interest rate environment. On the whole, it should be a report that isn’t bad at all, because the environment is one that is conducive to growth."

While Elbit Systems has underperformed, there are small defense companies on eh Tel Aviv Stock Exchange that have risen sharply. Aryt Industries (TASE: ARYT), for example, which makes fuses, and which announced a NIS 150 million order from the Ministry of Defense this week, has shot up 152% in the past year. Specialized camera company Next Vision (TASE: NXSN), and electro-optics companies Imco Industries (TASE: IMCO) and ThirdEye Systems (TASE: THES) have also risen sharply.

No comment was forthcoming from Elbit Systems.

Published by Globes, Israel business news - en.globes.co.il - on May 23, 2024.

© Copyright of Globes Publisher Itonut (1983) Ltd., 2024.

Elbit Systems  credit: Elbit Systems, processing: Tali Bogdanovsky
Elbit Systems credit: Elbit Systems, processing: Tali Bogdanovsky
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