Defense And Aerospace Demand Will Support Long Term Earnings Recovery

Catalysts

About TT Electronics

TT Electronics designs and manufactures specialized electronic components and power solutions for mission critical applications across aerospace and defense, healthcare, and industrial markets.

What are the underlying business or industry changes driving this perspective?

• Rising global defense and civil aviation spending, supported by multi year program awards such as the recent contract with Kongsberg, is expected to sustain high value, long duration orders and support continued revenue growth and operating margin expansion.
• Growing demand for higher efficiency, lighter weight power electronics in applications such as air mobility and advanced aircraft, underpinned by investments in technologies like silver sintering and the Altitude DC platform, should increase the mix of differentiated, higher margin products and lift group earnings over time.
• Customer driven reconfiguration of global supply chains, including onshoring and nearshoring into facilities such as Mexicali and Cleveland, positions TT to capture incremental EMS and design wins, improving asset utilization and supporting a recovery in North American margins.
• Structural growth in outsourced electronics manufacturing for healthcare and life sciences equipment, combined with TT’s expanded regional engineering and R&D capabilities, is likely to deepen blue chip customer relationships and drive higher recurring revenue and improved cash generation.
• Ongoing operational turnaround actions, including the closure of the loss making Plano site, productivity improvements at Cleveland and disciplined inventory reduction, should convert future top line growth more efficiently into profit, supporting a rebound in adjusted operating margins and earnings per share.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming TT Electronics's revenue will grow by 3.6% annually over the next 3 years.
• Analysts assume that profit margins will increase from -13.7% today to 9.7% in 3 years time.
• Analysts expect earnings to reach £52.1 million (and earnings per share of £0.15) by about December 2028, up from £-66.5 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting £63.0 million in earnings, and the most bearish expecting £46.3 million.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 5.9x on those 2028 earnings, up from -3.5x today. This future PE is lower than the current PE for the GB Electronic industry at 22.8x.
• Analysts expect the number of shares outstanding to grow by 0.23% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 10.64%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Structural growth in TT’s core Aerospace and Defense markets, supported by multi year contracts, record European order intake and NATO’s intention to lift defense spending towards 5% of GDP by 2035, could drive sustained high single digit or better revenue growth and operating leverage. This could push earnings and margins higher than implied by a flat share price.
• Successful execution of the North American turnaround, including the closure of the loss making Plano site, productivity gains and headcount reductions at Cleveland and the expectation that the region returns to profitability in the second half, could trigger a step change in regional profitability and group earnings. This could lead the market to re rate the shares.
• Ongoing balance sheet derisking through material inventory reductions, strong cash conversion of 135% and further planned deleveraging towards the lower end of the one to two times leverage range could support a resumption of dividends and improved investor confidence. This may lift the valuation and share price over time.
• TT’s investments in next generation technologies such as silver sintering power modules and the Altitude DC high voltage platform, together with long term blue chip customer relationships and new contract wins like the GBP 23 million Kongsberg deal, may accelerate mix shift into higher margin products and structurally raise net margins and earnings.
• Short term revenue softness in Asia and Automation and Electrification that is currently driven by tariff uncertainty, safety stock digestion and temporary end market weakness could reverse as geopolitical conditions and semiconductor equipment demand normalize. This could result in a cyclical rebound in revenue and operating profit that the current flat share price expectation does not anticipate.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The analysts have a consensus price target of £1.26 for TT Electronics 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 £1.5, and the most bearish reporting a price target of just £0.95.
  
• In order for you to agree with the analysts, you'd need to believe that by 2028, revenues will be £539.3 million, earnings will come to £52.1 million, and it would be trading on a PE ratio of 5.9x, assuming you use a discount rate of 10.6%.
  
• Given the current share price of £1.31, the analyst price target of £1.26 is 4.1% lower. 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.