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• Leonardo announces the early repayment of the Term Loan of €500 million with an expected interest rate expenses saving of almost €25 million per year.
• Possible order intake from the Nigerian Air Force that should be worth over €1 billion.
• Leonardo is the first group in the EU for loans from the European Defense Fund.
• The Germany-Saudi rapprochement may be worth over €1 billion.

Jozsef Soos/iStock Editorial via Getty Images

After our initiation of coverage of Leonardo S.p.a. (OTCPK:FINMF) with a neutral rating target, today we are back to deep-dive into the Italian defense company. Last time, we concluded that Leonardo was fairly priced and since our latest update, the company declined by almost 20%.

Here are the main key takeaways for the company for the next period:

1. On Tuesday 13th December, Leonardo announced to the financial community that on the 29th of December, it will make the early repayment of the €500 million term loan. These bonds rate expected to mature in 2039 and 2040 and have respective interest payments of 7.475% and 6.25%. This is a positive signal that according to our estimates will save on annual financial charges of approximately €25 million. This move will support Leonardo in reducing its gross and variable debt while helping to contain interest charges in 2023;

2. According to the Shephard Media news, the Nigerian president, Muhammadu Buhari, would have approved the purchase of six T-129 Atak helicopters, two multi-role Augusta 109 Trekkers, three Wing Loong II UAS, and 24 M346 training and attack aircraft, one of the classic models of the Italian company. The first deliveries could be carried out to NAF (Nigerian Air Force) as early as next April. For the moment, there is no comment on the price. However, while awaiting confirmation from the Nigerian forces, here at the Lab, we have estimated the value of the possible order for Leonardo. If it goes through, the contract could exceed €1 billion, a sum equivalent to about 7% of the order book estimated for 2023 at €15.8 billion. According to our estimates, this contract should also guarantee high profitability, supporting the recovery of the aeronautical division and the progression of margins in the group's electronics;

3. Leonardo is the company that secured more funding under the European Defense Fund (EDF). In detail, the Italian defense group was awarded a total of 19 projects, of which 5 concern the Cyber security division. This is a good sign because it means that Leonardo is considered capable of developing future technologies. EDF is the EU's tool to promote cooperation in the European space. In numbers, the funds allocated to Leonardo are worth over €1.2 billion and will accelerate the company's innovation;

4. The ongoing rapprochement of the UK and Germany towards Saudi Arabia may be a piece of good news for the Italian defense group. In 2018, Saudi Arabia signed an MoU to purchase 48 Eurofighter. However, the deal, worth approximately €11 billion did not go ahead due to a German embargo. Thanks to the German softening attitude towards the Saudis, this could be a positive catalyst for Leonardo with a benefit worth almost €1 billion;

5. There is no news on OTO Melara's potential disposal, as already mentioned, our internal team values the company between €500 and €600 million "but it could be worth more with new orders".

6. Going to the MICRO detail, the 2022 positive currency development evolution could be worth €150 million and €15 million in top-line sales and EBIT respectively. This is based on a €/$ exchange rate of 1.18 (based on Leonardo's internal assumption) against the current cross rate at 1.06;

7. The new Italian government should back Leonardo's strong order intake in Q4;

8. In Q3, Leonardo's CEO Alessandro Profumo confirmed the 2022 guidance further reassuring the defense sector experts;

9. Regarding the aerostructures division, Airbus has surpassed its 2019 output level, while Boeing (Leonardo's number one customer) is slowly recovering. The sector's goal of break-even has been reiterated. Currently, the Italian defense company is in advance negotiations with both Boeing and Airbus for new orders. If these contracts were signed, we estimated that Leonardo will generate additional sales allowing the break-even target to be exceeded. Considering the fact that the US military budget is increasing, we believe that Rada and DRS will also perform well;

10. We expect an increase in the European defense budget. This could also further increase Leonardo's fair value. Most of Europe spent around 1.5% of GDP (the UK and France were around 2%), but most countries plan to increase defense budgets. According to our estimates, this could add 145bp of growth per year to Leonardo, increasing just for that the fair value by €1.7 per share. However, the timing of these increases and how they will be spent remain uncertain;

11. Leonardo has immaterial exposure to Russia and Ukraine, the company wrote down only €38 million;

Over the years, Leonardo suffered from poor cash flow for various reasons (mainly due to the losses of the Aerostructures division). However, we estimate an FCF of around 9% for the whole of 2022 with an expected increase to around 13% in 2025. While we understand that high net debt may be a cause for concern, the latest debt development might soften the Investor community sentiment. Since the Russian invasion of Ukraine, armaments demand has increased globally and Leonardo is certainly benefiting from this. So much meat for Leonardo, given the stock derating to €7.5 per share, we confirm our previous target at €10.5 per share.

2023-04-15

Leonardo recovered quite a bit but is only now back to where it was five years ago.