Directed Energy And Unmanned Systems Will Drive Long-Term Defense Market Upside

Catalysts

About Elbit Systems

Elbit Systems is a global defense technology company that develops, integrates and delivers advanced systems across land, air, sea, space and cyber domains.

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

• Record $25.2 billion backlog, with close to 70 percent from customers outside Israel and multi year contracts such as the 8 year, 2.3 billion dollar strategic program, provides high visibility on sustained top line growth and supports operating leverage and earnings compounding.
• Structural rise in defense budgets, particularly in Europe where new facilities in Sweden and Germany expand local presence, is driving large orders for artillery rockets, loitering munitions and ISTAR suites, underpinning multi year revenue growth and scale driven margin expansion.
• Rapid adoption of unmanned systems and integrated sensor solutions, evidenced by over 20 Hermes 900 customers and cross selling of payloads and EW systems, should increase system content per platform and lift both revenue and gross margins over time.
• Commercialization of directed energy and other advanced energy weapons, including IRON BEAM and airborne high power laser programs, positions Elbit at the forefront of a new interception paradigm that can shift the mix toward higher value, higher margin solutions and stronger long term earnings growth.
• Company wide operational excellence, including a unified ERP, AI driven process optimization and automation in ammunition and munition plants, is already visible in the 1.5 percentage point operating margin improvement and should continue to enhance net margins and free cash flow conversion as volumes grow.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming Elbit Systems's revenue will grow by 9.3% annually over the next 3 years.
• Analysts assume that profit margins will increase from 5.9% today to 7.2% in 3 years time.
• Analysts expect earnings to reach $728.5 million (and earnings per share of $21.94) by about December 2028, up from $456.2 million today.
• 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 52.8x on those 2028 earnings, up from 51.5x today. This future PE is greater than the current PE for the US Aerospace & Defense industry at 29.2x.
• Analysts expect the number of shares outstanding to grow by 3.91% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.33%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• A normalization of global defense budgets after the current upcycle, particularly in Europe and Israel where Elbit is seeing outsized demand, could slow order intake and erode the visibility provided by the $25.2 billion backlog, putting long-term revenue growth and earnings compounding at risk.
• Aerospace and Elbit Systems of America already showed low single digit revenue declines in the quarter, and if U.S. defense spending remains limited to single digit growth or shifts priorities away from Elbit’s avionics and precision guided munitions, these structurally important segments could drag on consolidated revenue growth and net margins.
• The investment in high power lasers, directed energy weapons and other advanced energy systems may not translate into broad adoption outside Israel if competing technologies or regulatory constraints win out, which would leave Elbit with elevated R&D and CapEx burdens that dilute operating margins and depress future earnings.
• Elbit is benefiting from war driven demand for ammunition, munitions and loitering systems, but a durable ceasefire and de escalation in key regions could compress this structurally elevated demand, driving down high growth Land segment revenues and reversing some of the recent scale driven operating margin expansion.
• The current step change in profitability is tied to mix, AI enabled operational efficiencies and large multiyear contracts, and any execution missteps, cost overruns or delays on programs like the 8 year, USD 2.3 billion strategic solution could erode backlog profitability, reducing gross margin resilience and weakening cash flow and net income over time.

Valuation

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

• The analysts have a consensus price target of ₪1828.13 for Elbit Systems based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• In order for you to agree with the analysts, you'd need to believe that by 2028, revenues will be $10.1 billion, earnings will come to $728.5 million, and it would be trading on a PE ratio of 52.8x, assuming you use a discount rate of 9.3%.
  
• Given the current share price of ₪1635.0, the analyst price target of ₪1828.13 is 10.6% 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.