Aerospace Reliance And Execution Risks Will Pressure Margins And Justify A Bearish View

Catalysts

About TT Electronics

TT Electronics supplies high specification, customized electronic components and manufacturing services for mission critical applications across Aerospace & Defense, healthcare, automation and related industrial end markets.

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

• The decision to close the loss making Plano site in a weak distribution channel environment may only temporarily improve results. Once last time buy activity fades, the Components business could return to lower volumes, putting pressure on revenue and limiting recovery in adjusted operating profit.
• Reliance on long duration Aerospace & Defense programs and higher defense spending targets concentrates exposure in one end market. Any slowdown in orders or reprioritization of budgets could reduce visibility and compress the currently strong 15.6% European margin over time.
• Ongoing order delays in Asia tied to tariffs, geopolitical uncertainty and customer safety stock mean utilization in Suzhou and Malaysia may stay below capacity. This would weigh on operating leverage and keep group operating margins closer to the 5.5% level already reported.
• The transition of production from China to Malaysia for a major customer, covering more than £20 million of annual revenue, increases operational complexity and execution risk. Any disruption or slower than expected backfilling of Suzhou capacity could dampen top line growth and constrain earnings.
• Management’s focus on balance sheet derisking, inventory reduction and leverage within the 1x to 2x range limits flexibility to invest aggressively in new technology platforms such as advanced power electronics and EMS capabilities. This could slow future revenue growth and cap potential improvement in net margins.

Assumptions

This narrative explores a more pessimistic perspective on TT Electronics compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming TT Electronics's revenue will grow by 2.2% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from -13.7% today to 9.5% in 3 years time.
• The bearish analysts expect earnings to reach £49.4 million (and earnings per share of £0.27) by about January 2029, up from £-66.5 million today. However, there is some disagreement amongst the analysts with the more bullish ones expecting earnings as high as £62.3 million.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 4.7x on those 2029 earnings, up from -3.0x today. This future PE is lower than the current PE for the GB Electronic industry at 23.3x.
• The bearish 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 11.0%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• TT Electronics is positioned in long duration Aerospace & Defense programs where customer relationships often run for a decade or more, so sustained contract wins such as the recent £23 million Kongsberg award and record order intake in Europe could support long term revenue visibility and keep divisional margins, such as the 15.6% margin in Europe, more resilient than a bearish share price view assumes.
• The group is focused on end markets linked to long term megatrends, including defense spending commitments by NATO members, higher demand for civil aviation spares, and ongoing automation and electrification projects, which may underpin structural demand and support revenue and earnings even if near term conditions remain mixed.
• Operational fixes in North America, including closure of the loss making Plano site, turnaround efforts at Cleveland with productivity at target levels and lower scrap and rework, and prior improvement in Kansas City, could gradually remove profit drags and provide upside risk to adjusted operating profit and net margins compared with a pessimistic case.
• TT Electronics has been reducing inventory and improving cash conversion, with inventory down by £22 million and cash conversion at 135% in the half, while leverage of 1.9x sits within the 1x to 2x target range, which may give the company more financial flexibility than expected to support investment and stabilize earnings and free cash flow.
• Capacity across Asia, Mexico and North America, combined with long term EMS and power electronics capabilities and deeper business development efforts in growth regions, may allow TT Electronics to win additional programs or fill underutilized sites like Suzhou over time, which would support revenue and operating margins if order delays ease.

Valuation

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

• The assumed bearish price target for TT Electronics is £0.95, which represents up to two standard deviations below the consensus price target of £1.29. This valuation is based on what can be assumed as the expectations of TT Electronics's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of £1.55, and the most bearish reporting a price target of just £0.95.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2029, revenues will be £518.5 million, earnings will come to £49.4 million, and it would be trading on a PE ratio of 4.7x, assuming you use a discount rate of 11.0%.
  
• Given the current share price of £1.11, the analyst price target of £0.95 is 16.4% lower. Despite analysts expecting the underlying business to improve, they seem to believe the market's expectations are too high.
  
• 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.