Hensoldt AG (HAG) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by. Welcome, and thank you for joining the HENSOLDT 9 Months Results 2023 Analyst Call. [Operator Instructions] I would now like to turn the conference over to Veronika Endres, Head of Investor Relations. Please go ahead.

Thank you, and good afternoon, everybody, and welcome to HENSOLDT's 9M 2023 Results Call. Thank you all for joining us today. I'm Veronika Endres, Head of Investor Relations at HENSOLDT. With me are our CEO, Thomas Muller; and our CFO, Christian Ladurner. Thomas and Christian will guide you through the presentation today. And as always, this will be concluded by a Q&A session. And with that, I hand over to Thomas.

Yes. Thank you very much, Veronika. Good afternoon, everyone. Thanks for joining our earnings call today in which we would like to present our, once again, strong results for the first 9 months of 2023. Let me start by giving you a brief update on strategic topics and key business highlights. Christian will then guide you through our strong financial performance. And as always, following our presentation, we are really happy to answer your questions. Now ladies and gentlemen, to begin, let us have a look at the global security situation. Conflicts around the world have not only increased in number and intensity in the recent past, but have also become more and more interlinked, creating a global polycrisis. In addition to Russia's war against Ukraine, we have seen a flare-up of ethnic conflicts those in Caucasus and the Balkans and the terrorist attacks of Hamas have severely impacted the abolishment between Arab nations like Saudi Arabia and Israel. This increasing world disorder will be incredibly difficult to resolve any time soon. As a consequence, the need and demand for electric defense and security solutions -- electronic to neutralize a wide range of air, sea, land space and cyberspace is significantly increasing. In the first 9 months of 2023, we, at HENSOLDT, have once again demonstrated that our strategic position is ideal to provide our customers with innovative, high-end defense and security solutions in these challenging times. The significant growth in our core business is a strong signal. Our customers trust our reliability, innovative strength and our ability to deliver our solutions rapidly. So to accommodate these demands, especially the demands of our domestic key customer in Germany, we have increased our capacities and are ready to deliver. Now we, HENSOLDT, are strongly positioned for the future of warfare, with a focused capability in defense electronics, a platform-agnostic business model and the continuous investment in our portfolio and new capabilities. We see an increase in defense budgets around the world with an over-proportional increase in our market segment of defense electronics. You may remember that I talked about a [ Supercycle ] 2.0 for HENSOLDT at our Capital Market Day. And I remain absolutely convinced that we will see a further acceleration of growth in our market segment of defense electronics, creating a very strong outlook for our company. Our German core market remains strong, not only through the special fund of EUR 100 billion, but also through the commitment to spend 2% of GDP in defense sustainably. We also see positive developments in Europe, where the European Sky Shield Initiative for Air Defense is gaining traction and we will be positioned both with our TRML-4D and the Spexer 2000 radars in the middle of it. In addition, we will secure a number of contracts in the international market before the end of the year, and I will come to that a little bit later. Ladies and gentlemen, let me highlight a specific feature of HENSOLDT's business model and the key reason why I believe -- no, I can even say why I'm absolutely convinced that our business is really attractive. Sensors and defense electronics are force multipliers and key to the digitization of the battlefield. Sensor solutions transform airplanes, ships, and tanks into mission platforms of reconnaissance, intelligence, situational awareness, target acquisition, tracking and identification to name only just a few. It is guaranteed at sensors and electronics content will keep increasing. And that also the amount of data and the need of the data to be quickly used and transformed to actionable intelligence across all domains. And the inherent benefit of this is that we, HENSOLDT, sit on multiple platforms in all segments and are working towards getting on many more in the future. We do not only provide the most performing traditional sensors and center systems, but we are also investing in solutions to use sensor data and increase the speed of the military commandos targeting loop. And this, in all demands, air, sea, land, space and cyberspace. As a result, we do not just benefit from an increase in quantity of platforms sold, but also for more and higher value sensors per platform, which explains why the close in Defense Electronics is outpacing growth in overall defense spend. So to sum it up, at HENSOLDT, 1 plus 1, that's not equal 2, but at least 3, if not more. Now this slide has become stable in our quarterly presentations by now, and we like to continue showing it for an important reason. Despite the daily discussions on scheduling of individual projects, the overall outlook for HENSOLDT regarding the German programs in the short and medium term remains solid and HENSOLDT will contribute its leading technologies to many German programs in all domains. Yes, there are usual timing shifts that some programs be accelerated, while others are delayed. My key message to you is we at HENSOLDT are well positioned for a significant number of projects that will drive our business significantly for many years to come. And to be a bit more concrete, we expect a medium to high single-digit EUR 1 billion contribution from Germany to our order intake in the coming years. And you see in our 9-month figures for 2023 that this is materializing more. Now this slide shows 4 important projects of our German customer, where we expect to book the order intake before end of this year. Let me highlight the 2 biggest items for the short and very short-range air defense system, NNbS. We contribute our TRML-4D and Spexer Radars to state-of-the-art short range air defense systems of the Bundeswehr that will allow protection of groups even on the move. The Eurofighter MK1 rebaselining is an add-on to the original Mk1 contract as the customer requires additional features for the radar, which we will certainly develop. This type of add-on or extension contracts are characteristic for the big development projects, we have one and there are high probability that over the lifetime of the project, more of these add-ons will materialize. The 4 topics in this slide alone amount to almost EUR 400 million. And in combination with many other projects we are chasing will contribute nicely to our substantial order intake by the year end. But we do not only rely on our admittedly strong domestic markets. As mentioned earlier, we see an increasingly strong dynamic in our international business development. For this slide, we have picked 5 programs which -- with a total contract volume of almost EUR 250 million, where we also are close to the finish line to book the order intake in the coming months. These potential orders are a testament to our state-of-the-art product portfolio and our tenacity and perseverance to nevertheless go for the yield we are chasing. Before I hand over to Christian, I would like to highlight the topic on the execution side of our business. In October, we have successfully passed the critical final review of PEGASUS. This is an important milestone as a critical design review pays the way for the continuation of the project into the implementation phase and also unlocks payments, milestones in excess of EUR 200 million. For me, the CDR is an excellent proof that HENSOLDT has a capability to master complex system integration projects and manage them effectively. And on this positive note, I'm happy to hand over to our CFO, Christian.

Thank you very much, Thomas, and I'm happy to provide you now with the details on our financials for the first 9 months 2023. We again were able to realize a strong top line performance in the first 9 months of this year. Our order intake summed up to nearly EUR 1.3 billion. This performance was driven by our strong baseline business as well as the orders for TRML-4D radars and systems for the Puma and Leopard 2 platforms. The distribution of incoming orders was very well balanced between our home market Germany and Europe. Our sales increased to EUR 1.14 billion, driven by strong growth in the sensor segment. As already seen in the H1 results with a significant growth of core revenue by 15%. This is a result of the excellent development of our baseline business and a decline of pass-through revenue. The key program, Eurofighter MK1 and PEGASUS developed as planned with a further successful milestone achievement in the PEGASUS program, as explained by Thomas earlier. At the end of the first 9 months of 2023, our order backlog summed up to almost EUR 5.5 billion. This covers around 3x of our guided revenue for 2023 and therefore, continues to provide us with an excellent revenue visibility. The strong performance of our top line has also reflected an excellent development of our profitability. Adjusted EBITDA increased by 20% year-on-year to EUR 151 million with an adjusted EBITDA margin of 13.3%. Our core margin, excluding cost revenue increased as well to 15%. Adjusted EBIT summed up to EUR 94 million with an adjusted EBIT margin of 8.3%, respectively, 9.4%, excluding pass-through business. This excellent performance was mainly driven by higher volumes and the significant growth of our core revenue as described earlier. On top, we were able to realize economies of scales and programs such as the TRML-4D. This development was partly offset by investments in our growth ahead as well as by an unbeneficial product mix. Adjusted pretax and levered free cash flow amounted to minus EUR 126 million. The development in the first 9 months follow our typical business profile, characterized by investments in working capital to prepare for the planned revenue recognition in the fourth quarter. The recent milestone achievement is in the PEGASUS program and also for Eurofighter MK1 provide us with an excellent cash visibility now. The milestones in this program will result in significant cash inflows of around EUR 350 million in Q4, of which around EUR 100 million of pass-through, meaning the EUR 250 million stay within HENSOLDT. So let me point out our overall bottom line develops as flat. Let's now have a look at our segments. In the sensor segment, order intake developed as planned with orders booked for TRML-4D radars for Ukraine and the German armed forces as well as the most self-protection system for the Puma tank. Please be reminded that the previous year's figures included several key orders for the equipment of F126 frigates for Eurofighter C3 service contract and the Halcon program with a total volume of more than EUR 600 million. Revenue in the Sensors segment increased by 4% to EUR 952 million. And again, I want to highlight that our core revenue increased even stronger by 18%. As outlined before, our key programs, Eurofighter MK1 and Pegasus are developing as planned, also contributed very well to our revenue. The margin performances of the sensor segment was excellent with an increase in adjusted EBITDA of 47% to EUR 155 million. The uplift in absolute margin was driven by higher volumes and by economies of scale in some programs, for example, TRML-4D. But please also be remind that within our diversified portfolio, scaling effects in some programs might compensate for investments into growth and other projects. In the Optronics segment, order intake showed still and again a sustained high momentum. Main order intake drivers were the Puma 2 batch and the Puma retrofit. The Leopard 2 for Norway and Sweden as well as periscopes and optical mast systems for the Norwegian Ula-class submarines. As some of these large orders take some time to convert into sales, they did not yet boost revenue growth in the short term. Revenue, therefore, grew only slightly by 2% to EUR 188 million. Main drivers were our high-performance optics FFM periscopes and optronic mast systems for submarines as well as the laser rangefinder for the M1 Abrams main battle tank of the U.S. Adjusted EBITDA optronics amounted to minus EUR 4 million. On this, let me remind you that on the one hand, we are investing in the ramp-up of the production as well as in the digitalization of the optronics portfolio in order to realize the upcoming growth. And on the other hand, margins were temporarily affected by less beneficial product mix in the first 9 months of this year. So let me point out the growth effects that currently impact our Optronics margin are not a structural nature, but necessary to secure the planned growth and we will see increasing revenue and margin dynamics again in Q4. Let's talk about our guidance for the full year 2023 as well as our midterm outlook. First and foremost, we remain on track to deliver on our full year targets. For 2023, we continue to expect a book-to-bill between 1.1 and 1.2x. Revenue of EUR 1.85 billion, the stronger growth in core revenue, resulting in an improved quality of revenue. An adjusted EBITDA margin of around 19% before pass-through revenue and around 70% cash conversion for pretax unlevered free cash flow resulting in a further decline in net leverage to lower or equal than 1. And finally, a dividend payout ratio between 30% and to 40% of adjusted net income. Coming to a conclusion, let me mention the following key financial takeovers. In the first 9 months of this year, we have achieved an outstanding performance that formed the basis for a successful year 2023. We secured again a strong order intake, resulting in a high order backlog of EUR 5.5 billion. This continues to provide us with a great revenue visibility for the years to come. Our efficient project execution supports our very strong profitability. And in addition, our core revenue increased significantly with an excellent cash visibility supported by the successful milestones in our key programs. Therefore, we confirm our guidance for full year 2023 and midterm. Our outlook remains promising, and we are strongly positioned for the upcoming growth. The procurement plan of the German government is accelerating, and we expect further orders in the short term. We continue to be in close exchange with the German customer regarding the programs and opportunities from the special fund. We expect several international programs to be booked in the near term. And this will generate long-term sustainable growth. And now we are happy to take your questions.

[Operator Instructions] The first question is from the line of Carlos Iranzo Peris with Bank of America.

I actually have two. The first one on Optronics. What has been driving the weak performance at the top line level in the third quarter? Is there any one-off? And then on the margin side, how should we think about margins in Optronics, midterm. And then second question on sensors and the percentage of pass-through revenues. Year-to-date, you have reduced the percentage of past revenues significantly versus last year. How should we think about the percentage of pass-through revenues for 2024?

So first of all, electronics performance, we should not forget that the first half year was very strong in order intake at Optronics, and we will see the materializing of these orders in the revenues from Q4 onwards in the next quarters. So I expect, of course, the growth we have announced also happened in the optronics. Regarding margins, we've mentioned already in the half year financials that we see an impact out of the necessity to invest in the growth of around 2.5% to 3%. We see this now for this year, and we will see the next 1 to 2 years due to this growth. But this is how you should look at the Optronics segment, always knowing that it will be balanced by sensors and the economies of scale we can realize there. So in total, the group is on track regarding the margins. So this is in the optronics. Regarding your questions of the pass-through. So for this year, you should assume around EUR 100 million less on a year-to-year comparison. Going forward, we see a pass-through revenue amount of around EUR 100 million to EUR 150 million per year from 2024 onwards, depending on the milestones of the respective projects.

The next question is from the line of Ross Law with Morgan Stanley.

I've got two, if I may. Firstly, just on order intake, it looks like you need roughly EUR 750 million of orders in Q4 to hit the bottom end of your guidance range. But you've called out several German and international opportunities that could contribute EUR 650 million. So I'm assuming there are other orders out with the big ticket items you flagged. Should we be thinking more towards middle end or even the high end of that guidance range for the full year for orders? That's the first question. And secondly, just on FCAS, just regarding recent media speculation that Germany might be thinking to exit that program. I'm just wondering how that would potentially impact HENSOLDT and also your views on that report.

So first question on order intake, yes, your calculations are good. We should not forget the baseline, we call it baseline business for small projects and also in the service business and this brings us to the guidance. We see ourselves still in the 1.1 to 1.2x. We will see how the year turns out. But as you see, we have a good visibility on upcoming orders. We see ourselves very comfortable with this margin guidance. The order intake guidance, sorry for that. Yes.

And what you didn't mention, Christian, we already got some of these orders we have mentioned in October, November. So we are very confident to be on a good track, as Christian mentioned. So second, your question to the Future Combat Air System. Now we also got the contract on an R&D contract for the next years to work on very, very new technologies for the Future Combat Air System. So whatever is published in the newspapers, I cannot share this because we are working on this as our partners do, too. Now you remember what you always said, we believe that the FCAS program, again, I have to devise myself. We are very confident that the FCAS program will go ahead. And on top, there may be an additional opportunity for us to have a closer relationship between the U.K. program, the U.K. Leopard program between U.K., Italy and Japan and the Future Combat Air System, which is between France, Spain and us. So if there are 2 different programs in the future long term or it will be merged into one big program, I don't think there's a huge difference besides one, the business opportunity is even going for us.

The next question is from the line of Christophe Menard with Deutsche Bank.

Yes. I had 3 actually. First one is on understanding the core revenue growth, which -- correct me if I'm mistaken, but last year, you were more growing around 7% the core revenue growth. This year, it's 15%. What is the sustainable level, in your view, given the order intake. That's the first question. The second, I was wondering, I mean, in terms of the past and the level of free cash flow, I understand that the reason for the free cash in the first 9 months is linked to quite obviously some milestones that had to be passed. Should we see a relationship between your free cash flow and the absence of pass-through on a quarterly basis? So if you could just help us understand that dynamic. And the last question is on M&A, if you could update us on -- well, on the pipe, basically and what I mean I know it's a regular question, but any update is useful.

So yes, your calculations were right. Last year, we were at around 7%. This year, it's around 14%. When you go to our guidance and you see the midterm guidance, we said that we see a growth in average per year of around 10% and now keeping in mind that the pass-through will stay on a somehow constant level in the next 1 to 2 years, you see how we think about the growth, and this is also, from my point of view, reasonable. Secondly, I do not see a connection between pass-through revenue and cash flow. The method is the same as we do in our normal revenues. You have some milestones where you recognize revenues on a cost-by-cost basis. And when the milestone is there, you receive the cash. What is really different according to the last years that some main -- some major milestones were now in September means that including charging of the invoice and the payment process ongoing that most of the cash will arrive at us in the first 2 December weeks, but the visibility we have makes us very comfortable in this regard or we already got it.

M&A.

Christophe, on the M&A, you remember what you always said, Strategically, we will grow organically, but also through acquisitions. That's what we have said all the time. Now there is 1 very, very important thing to mention again. We only go for any M&A if it's a treat and if we have a very good benefit of an M&A. So we can't talk about any specific targets.

Okay. Just if I may, on the first question on the core revenue growth going back to it. I mean, yes, that's your guidance midterm. But I mean, what we've seen in 2023, is it the -- I mean, is it -- I mean, the sign of a step-up or you would say, well, it's kind of where the figures are and we're sticking to the 10, kind of, percent around or is it -- does it show some sort of an acceleration materializing.

Christophe, sorry, could you repeat your question, please?

Yes. The question is just I was wondering versus your midterm guidance for the core revenue growth. The fact that it is slightly above in 2023. Does it mean that the trend is accelerating so that you may have to revisit that guidance upwards? Or is it just one element of the year unfolding as it is? I'm just trying to understand whether this is a trend or it's some sort of a one-off that we're seeing in 2023.

So first of all, I think in terms of structure of cost revenue last year was an enormous big portion of revenues. Now we go down of around EUR 170 million in the next 2, 3 years to EUR 250 million. So this is the 1 in terms of being more concrete for 2024 onwards you should give us 3 months until we published the year-end figure 2023. And then we are also clear which milestones have not materialized and which are ahead of us to give you more details around that.

[Operator Instructions] There are no further questions at this time. I will now hand back over to Veronika Endres for any closing comments. Thank you.

Yes. Thank you all for listening today. We are very much looking forward to meeting you at our Capital Markets Day in all on November 22. And if you have not registered by now, you still have the chance to do so, just drop us an e-mail. And as always, should you have any further questions, the IR team is around all day to follow up. With that, have a great day. Thank you very much, and goodbye.

Ladies and gentlemen, the conference has now concluded, and you may disconnect your telephone. Thank you for joining, and have a pleasant day. Goodbye.