Robust Order Pipeline And Software Focus Will Secure Long-Term Success

Key Takeaways

• Strong order backlog and strategic shift towards software-centric models could drive significant top-line growth and enhance margins.
  
• Expanding defense market and M&A opportunities are poised to boost revenue and broaden global market presence.
  
• Frequentis faces challenges in short-term revenue growth, net margins, liquidity, and profitability due to project delays, R&D spending, and geopolitical uncertainties.

Catalysts

Develops and markets communication and information systems for safety-critical control centers in Europe, North America, Asia, Australia, South America, Middle East, Africa, and worldwide.

• Frequentis has a robust order backlog and pipeline, with orders on hand up 22% to €724 million, providing strong visibility into 2025 and beyond. More than half of the current orders on hand are expected to convert into revenue in 2025, potentially driving top-line growth.
  
• The company is focused on evolving its business model towards being more software-centric, which is generally higher margin than hardware. This strategic shift, coupled with ongoing product innovations like the MosaiX platform and increased investment in R&D, could enhance EBIT margins over time.
  
• Growing defense budgets, particularly in NATO and NATO-friendly countries, are expected to increase demand for military air traffic control solutions, which currently constitute 20% of Frequentis's revenue. This increase could bolster revenue growth as defense expenditures rise.
  
• Frequentis's global reach and expansion into emerging markets, like the integration and defense against drones and other mission-critical services, align with increasing security needs worldwide, likely expanding their addressable market and boosting revenue.
  
• The company is actively exploring M&A opportunities to expand its product portfolio and market presence, potentially increasing revenue and improving profitability through enhanced product offerings and economies of scale.

Frequentis Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Frequentis's revenue will grow by 7.6% annually over the next 3 years.
• Analysts assume that profit margins will increase from 4.6% today to 5.1% in 3 years time.
• Analysts expect earnings to reach €30.6 million (and earnings per share of €2.3) by about May 2028, up from €22.0 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 20.7x on those 2028 earnings, down from 23.7x today. This future PE is lower than the current PE for the DE Aerospace & Defense industry at 70.9x.
• Analysts expect the number of shares outstanding to remain consistent over the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 5.14%, as per the Simply Wall St company report.

Frequentis Future Earnings Per Share Growth

Risks

• Frequentis' focus on long-term defense projects means that while defense budgets are growing, any positive impact on revenue from military investments may take several years to materialize. This lag can limit short-term revenue growth.
  
• The slowdown in the ramp-up and revenue recognition of large, long-term projects in the PST segment, especially those in the U.K., Malaysia, and Switzerland, suggests potential delays and execution risks that could impact net margins.
  
• The company's heavy reliance on internal R&D spending, which remains at €30 million without capitalization, could limit net income growth if revenues don't scale proportionally.
  
• The significant percentage of net cash composed of customer prepayments (50%) could pose liquidity risks if these are not replaced with incoming cash from new orders which can affect cash flow stability.
  
• Geopolitical uncertainties such as potential U.S. tariffs and the company's dependence on imported software licenses may pose unpredictability in operating margins and cost structure, impacting overall profitability.

Valuation

• The analysts have a consensus price target of €41.802 for Frequentis based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of €45.0, and the most bearish reporting a price target of just €37.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be €600.1 million, earnings will come to €30.6 million, and it would be trading on a PE ratio of 20.7x, assuming you use a discount rate of 5.1%.
• Given the current share price of €39.3, the analyst price target of €41.8 is 6.0% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.