Elbit Systems conundrum: Rising orders, falling stock

Defense budgets around the world are rising, and defense companies are benefiting from the growing demand for their products. Elbit Systems (TASE: ESLT, Nasdaq: ESLT) also continues to report large contracts. Its backlog of purchase orders reached a record $17.8 billion at the end of last year, and just this week the company announced $760 million worth of contracts to the Israeli Ministry of Defense, the latest of many similar announcements in the past few months, with large orders coming from United States, Europe and Australia.

However, while defense stocks are up about 8% so far this year and 18.5% over the past 12 months, Elbit stock is in the doldrums. The stock price is down 6.2% year to date, just under $200, which is similar to where it was before the Iron Sword War broke out in October last year, giving the company a market value of $8.9 billion. Elbit Systems, which is headed by Bezhalel Machlis and controlled by Michael (Mickey) Federmann's Federmann Enterprises (44%), is scheduled to release its first-quarter financials next week.

“Foreign investors are not interested in the Israeli market”

What is the explanation for the stock's poor performance? Two of the analysts we spoke to mentioned negative sentiment towards Israeli stocks. “Elbit is Israeli stocks, and there are many good Israeli stocks that are underperforming – Bezeq, banks, Bazan, which achieved record results and the share price fell,” says Liran Lublin, head of research at IBI Investment House. “Foreign investors are we are not interested in the Israeli market.” , the Israelis themselves decide to look abroad, and we see a lot of foreigners exiting the stock, and not enough Israelis are buying to stop the decline.

“There is a trend of anti-Israel sentiment, which could put a great deal of pressure on foreign investors to sell shares,” adds Omri Evroni, an analyst at Oppenheimer Israel. He cites Bank of Nova Scotia, whose asset management subsidiary Scotiabank recently sold a 40% stake in Elbit. According to a filing with the US Securities and Exchange Commission, the bank had a 2.5% stake in Elbit at the end of the first quarter, compared to 4.2% at the end of the previous quarter. This is after it sold its shares in the fourth quarter as well. This means stock sales of about $150 million during the first quarter. If the bank still had the same stake today, it would be worth $225 million. In Evroni's view, the bank did not want to be associated with the stock. Bloomberg has reported in the past that the bank has been the target of protests and petitions over its holding in Elbit.

Evroni says that in addition to the pressure on foreign investors, the problem also lies in the low liquidity of the stock on the Nasdaq stock exchange, which leads to its decline. He believes that at the same time there are institutions that want to invest in defense stocks, due to high defense spending in the United States and Europe, so that new buyers could come in, but it is difficult to know when that might happen. Oppenheimer gives Elbit an “Outperform” rating with a price target of $256, 28% above the market.

According to IBI's Lublin, another factor negatively impacting Elbit Systems, albeit to a lesser extent than the overall negative sentiment, is cash flow. “Ultimately, when you look at last year's numbers and going forward, you see impressive growth in order backlog and in revenue, and a supportive macro environment, as defense budgets around the world are rising,” he says. “Elbit entered the period with a somewhat higher price-to-earnings ratio, reflecting market expectations for growth. All of that has yet to trickle down to the company's cash flow. The Defense Ministry repaid its debt in the fourth quarter (Elbit previously reported that the Israeli Ministry of Defense had not It paid off its debts (S.H.V.) but then the cash flow gap appeared again.”

“What matters to the market in periods of uncertainty is not just growth, but the amount of cash flow a company can generate, and this is where Elbit has more work to do,” adds Lublin. 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 next week's quarterly financials?

Efroni: “Basically I would like to see an improvement in operating profit margin. On the demand side, there are no concerns. We would like to see the company's ability to improve equity and operating profit, and reduce financing expenses.”

Lublin: “I assume we will see in the reports good growth in the revenue line, and more good growth in the order backlog – we have seen the contracts that have been signed. Financing expenses will be high, at a similar level compared to previous quarters, due to the overall interest rate environment, it should The report is not bad at all, because the environment is conducive to growth.

While Elbit Systems underperformed, smaller defense companies on the Tel Aviv Stock Exchange rose sharply. For example, ARYT Industries (TSE), which makes valves and which announced a NIS 150 million order from the Defense Ministry this week, is up 152% in the past year. Specialty camera company Next Vision (TASE: NXSN) and electro-optics companies Imco Industries (TASE: IMCO) and ThirdEye Systems (TASE: THES) also rose sharply.

There was no comment from Elbit Systems.

Published by Globes, Israel Business News – en.globes.co.il – on May 23, 2024.

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