Acquisition Of E3A And Energy Transition Focus Will Boost Future Prospects

Key Takeaways

• Strategic focus on high-margin Energy & Environmental solutions and operational efficiency to improve long-term revenue and earnings quality.
  
• Expansion into digital and advisory services, alongside infrastructure and industrial market diversification, to drive future revenue growth and profitability.
  
• Strategic divestments and shifts, along with market disruptions and high tax rates, present risks to Ricardo's revenue, profitability, and financial stability.

Catalysts

Provides environmental, technical, and strategic consultancy services in the United Kingdom, Europe, North America, China, rest of Asia, Australia, and internationally.

• The divestment of the Defense business and acquisition of E3A aligns with Ricardo's strategy to focus on high-growth and high-margin Energy Transition & Environmental solutions, potentially improving long-term revenue and earnings quality.
  
• Ricardo's focus on operational efficiency, evidenced by a 430 basis point improvement in operating margins and cost reductions, is expected to enhance net margins and profitability in future periods.
  
• The company's strategic shift towards advisory and technical solutions for large infrastructure projects, supported by the E3A acquisition, is likely to create revenue synergies and boost revenue growth.
  
• Significant order growth in Energy & Environment and Rail segments, along with strategic diversification into industrial markets, should drive future revenue growth and support profitability as macroeconomic conditions stabilize.
  
• Increased focus on digital revenue streams and recurring digital and IP revenue, which offer higher margins, is expected to contribute to earnings growth and margin expansion over the medium term.

Ricardo Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Ricardo's revenue will decrease by 1.8% annually over the next 3 years.
• Analysts assume that profit margins will increase from -0.3% today to 2.5% in 3 years time.
• Analysts expect earnings to reach £11.0 million (and earnings per share of £0.15) by about March 2028, up from £-1.2 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting £12.8 million in earnings, and the most bearish expecting £5.5 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 27.8x on those 2028 earnings, up from -133.8x today. This future PE is greater than the current PE for the GB Professional Services industry at 23.2x.
• 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 9.02%, as per the Simply Wall St company report.

Ricardo Future Earnings Per Share Growth

Risks

• The divestment of Ricardo's Defense business was strategically timed to prevent a substantial future revenue and profit decline, indicating potential vulnerability if such divestments or strategic shifts do not occur as planned. This could impact earnings and future profitability.
  
• The Energy & Environmental business faced underperformance in H1 due to global election impacts and market disruptions, leading to revenue delays. If these factors persist, they could affect revenue and profit growth expectations.
  
• The Automotive & Industrial segment experiences variability and order intake delays, reflecting potential revenue uncertainty, especially with the shifting focus from automotive to industrial markets. This could influence earnings consistency.
  
• The planned substantial CapEx for the marine framework agreement and refinancing needs point to potential cash flow and leverage management risks, which could affect net margins and overall financial stability if not managed effectively.
  
• High tax rates in specific jurisdictions, especially following acquisitions like E3A in Australia, can impact the net margin, potentially reducing the anticipated profitability from new business integration and expansion efforts.

Valuation

• The analysts have a consensus price target of £3.819 for Ricardo 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 £5.4, and the most bearish reporting a price target of just £2.3.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be £450.3 million, earnings will come to £11.0 million, and it would be trading on a PE ratio of 27.8x, assuming you use a discount rate of 9.0%.
• Given the current share price of £2.58, the analyst price target of £3.82 is 32.4% higher.
• 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.