Saab: Overvalued For A Reason, But Still Overvalued – ‘Hold’ (SAABF)

Pricey readers/followers,

I have never really lined SAAB (OTCPK:SAABF) (OTCPK:SAABY) for you earlier than on Looking for Alpha. This was not an intentional oversight, however the reality is that I’ve by no means owned the inventory. With the struggle in Ukraine, each European navy or semi-military firm noticed a rise in sentiment and in addition probably their share value. So did SAAB. The corporate has gone from being really undervalued – although I, sadly, didn’t purchase them on the time – to being considerably and really clearly overvalued presently.

Regardless of elevated demand and NATO membership, I don’t consider that Sweden’s premier navy firm makes for an important funding presently.

Nonetheless, as a result of reader requests, I am joyful to make the journey to Stockholm – figuratively talking – to present you my view on SAAB and the place it is going.

What does SAAB do?

SAAB, which stands for Svenska Aeroplan Aktiebolaget is a Swedish military-industrial firm – a protection contractor with a global profile.

Its unique founding was as a producer of planes again in 1937 at the side of Bofors AB. This was performed on the instruction of the Swedish authorities, to safeguard native manufacturing of aggressive fighter planes. Many Swedish industrial “profiles” on the time have been a part of this, together with the Wallenbergs, The Wenner-Grens, and the Wingqvists. The corporate shortly absorbed native competitors, and throughout the interval after the second world struggle, the corporate grew to become a large contributor to the rise in Swedish protection spending.

The corporate developed the SAAB 29 Tunnan (The “Barrel”), the SAAB 32 Lansen (The “Lance”), And the SAAB 35 Draken (The “Dragon”), the final one which flew its inaugural flight in 1955. SAAB shortly established itself as a top quality producer, with Tunnan beating a number of world information throughout the first years, and the primary SAAB prototype flying in 1948.

The corporate expanded and adjusted all through the chilly struggle, and after the chilly struggle as nicely. One of many main adjustments was made within the yr 2000, when SAAB was merged with Celsius, together with ex-Bofors, which noticed all Swedish aerospace, robotics, and flight robotics (navy) growth/manufacturing all gathered beneath SAAB. The Bofors artillery section was moved to BAE Techniques (OTCPK:BAESY), with the remaining going into SAAB Bofors Dynamics.

SAAB at present is maybe most recognized for the SAAB 39 Gripen (The “Griffin”) is a light-weight, single-engine supersonic multi-role fighter airplane with a primary flight in 1988, introduction in 1996, and at present in use by Sweden, Brazil, South Africa, Czech Republic, Thailand, and Hungary. The airplane replaces the Dragon and the “Bolt” plane.

General the SAAB 39 competes with the Dassault Aviation Rafaele, The F-21, the F/A-18, and the Eurofighter Hurricane. You may see the Gripen in operation by smaller nations with smaller protection budgets as a result of that is what they have been constructed for. In comparison with the F-16, the fighter is far more cost-effective in operation and has higher avionics and sensor capabilities. The F-16 in the meantime, excels at agility and maneuverability. The Gripen is commonly in comparison with the F-35 Lightning II, however this can be a moot comparability as a result of the F-35 is a fifth-generation fighter – Gripen is simply fourth, and would most often lose given the higher sensors and sights of the F-35 – and the previous fighter adage “Lose the sight, lose the combat” applies right here.

SAAB really dropped the ball with its fifth era for my part, being a a lot smaller enterprise than Lockheed (LMT) or Airbus (OTCPK:EADSY), and its present fifth-generation fighter continues to be in prototyping. The undertaking is named “Flygsystem 2020”, or FS2020, and the goal is to develop a low-observable fighter jet inside the subsequent 12 years. So we’ll see what occurs right here.

I’d characterize the Gripen as a failure, although it’s not a nasty plane. The product has did not garner curiosity from consumers, and the nations which have declined are excess of the nations that function it. Curiosity within the Gripen got here from Argentina, Ecuador, Estonia, Kenya, Latvia, Lithuania, Malaysia, Mexico, Namibia, Peru, Serbia, Slovenia, Vietnam, and Eire. None of those function Gripen at present, and I’d think about that the curiosity to obtain bids from a 4th-generation fighter at this stage is proscribed.

Failed bids are additionally recorded in Bulgaria, Canada, Croatia, Denmark, Finland, India, Indonesia, Netherlands, Norway, Poland, Slovakia, Switzerland, Belgium, Oman, Romania, Pakistan, and Chile. We will not even curiosity our personal neighbors within the product – once more, not as a result of it is a dangerous product, however as a result of most nations appear liable to decide on F-35s or F-16s or a mixture of them as a substitute. Finland, for example, selected the F-35.

Are we beginning to get the image?

If SAAB desires to stay aggressive, they should get severe not simply in planes, however in different areas as nicely.

Again to the excessive stage

The corporate SAAB is owned, not majority, however over 30%, by the Wallenbergs by way of Investor AB (OTCPK:IVSXF) and their basis. This makes Investor AB an important selection for passive investing in SAAB, which is what I’ve performed. Similar with Ericsson (ERIC). I do not need direct publicity to both, so I am going with Sweden’s largest funding firm.

The biggest overseas possession stake in SAAB is AllianceBernstein with virtually 5%, after that, it is principally different giant establishments at 2-3%.

The corporate trades beneath the native SAAB-B ticker in Stockholm. It has a particularly meager yield of lower than 1%. It additionally would not have a credit standing, however I’d argue given its possession construction and the way it works, it doesn’t want a credit standing. Money availability or debt is not the corporate’s downside.

Neither is profitability. On a excessive stage, SAAB is nicely price a glance on a comp foundation. The corporate manages above-average working margins of round 9% for a protection contractor, with a internet margin of over 6% and an ROIC of 6.21%. Its debt/EBITDA is lower than 2.5x. And regardless of my lengthy outlay on aerospace, it is really not SAAB’s largest section. The corporate is principally a surveillance enterprise, with the next segments.

Kockums is the submarine section – and right here I’d argue, lies among the firm’s grandest worth. Sweden, and particularly SAAB and Kockums, makes among the finest submarines on earth, and with NATO entry, NATO now has entry to this. Sweden operates quite a lot of Gotland-class submarines, which grew to become well-known in 2005 after sinking a US plane service in a coaching train.

Sweden at present operates three such submarines, and it is these that, leased to the US Navy, “sank” the USS Ronald Reagan (CVN-76) – and the sinking wasn’t a single feat. It really managed to sink the service a number of instances with out the Nimitz-class service having the ability to be defended. Within the phrases of naval analyst Norman Polmar, cited in a enterprise insider article:

The naval analyst Norman Polmar stated the Gotland “ran rings” across the American service job power. One other supply claimed US antisubmarine specialists have been “demoralized” by the expertise.

(Supply: Enterprise Insider)

And this was a “low-cost diesel-powered sub” with lower than 1,700 tons of displacement that, on the entire of it, prices lower than a single F-35 stealth fighter managing to sink a billion-dollar service.

SAAB is already constructing the successors, with the Blekinge A26-class sub at present laid out, citing improved communications, much more, silent operation, and prospects for UUVs. The love for Swedish subs is evident, with only some days in the past the corporate submitted a bid to switch the Netherlands submarine fleet with SAAB-built new merchandise.

Bear in mind, Sweden as a nation requires protection not as a lot on land (primarily, excepting northern Sweden), however totally on the water and within the air – our navy is constructed – or was – constructed for this.

For SAAB, this implies altering for the instances. Which means elevated protection spending.

Clearly, Swedish protection funds sizes are rising as nicely.

Listed below are among the main applications at present related for SAAB.

I haven’t got a problem with the notion that elevated spending means elevated attractiveness and earnings for SAAB. I’d agree with that notion general. I’d additionally say the corporate has a justifiable share of enchantment on a global foundation, with clear progress targets now that NATO is on the horizon.

The corporate has set new targets with the introduction of NATO and the Ukraine struggle. The corporate now expects 10% annual natural gross sales progress, and working earnings larger than the gross sales progress, with a 70% or above money conversion, cumulative over the approaching 5 years. SAAB USA is clearly an enormous a part of that, and fortunately the publicity to the American market is critical.

Examples embrace the AT4 anti-armor weapon, with over 700,000 models offered within the US market alone, SAAB surface-based radars on six lessons of US Navy ships, and a $200M+ backlog in undersea techniques. The world is rising rather a lot much less secure, and nations are arming up – China included. The USA and different nations, together with Sweden, must do the identical, and SAAB is a big a part of this for our nation.

SAAB may be summarized very like the Gripen airplane, which was one of many causes I discussed the product as a lot as I did within the preliminary a part of the corporate. “It is a good product/firm, however….”

On this case, the “however” refers back to the huge valuation enhance we have seen over the previous yr and extra. SAAB is a good enterprise on the proper value, and it has earnings stability in addition to dividend stability over time. It would by no means be a excessive yielder or perhaps a sector-competitive yielder, that is how I see it.

However by shopping for on the proper value, the corporate can ship security and stability coupled with the standard bursts of progress you see related to elevated protection spending.

That is how I spend money on protection contractors. I’ve performed so with Common Dynamics (GD), Lockheed Martin, RTX (RTX), L3Harris (LHX), and Huntington Ingalls (HII). I’ve invested in all of them and offered all of them throughout overvaluation. Within the case of LMT, I offered my ultimate shares at $450. I could remorse this going ahead, however I additionally wish to remind you that these firms are literally pretty risky, having the potential to go up and down, after which keep beneath 13x P/E for greater than 5-7 years throughout “dangerous instances”. I not too long ago began shopping for again RTX.

SAAB is identical method, solely it is much more risky.

Check out the valuation.

SAAB Valuation – not a lot to love.

Whereas the general long-term trajectory is a constructive one, it is a very tall order to assert that one might have even remotely foreseen the current enhance, and your place might have been detrimental for over 5 years if you happen to held it on the “improper” instances.

I consider shopping for SAAB and comparable smaller contractors may be very tough – and paying what at present quantities to a normalized P/E of just about 33x, shouldn’t be a great way to do that, regardless of the expansion prospects. The corporate is already down from its final highs of over 630 SEK for the native shares.

Given its security, over time I’d be prepared to forecast SAAB at round 17-18x P/E. This involves a present share value of simply 400 SEK for the 2023 yr, and that is with a 35% adjusted EPS enhance. In fact, the analysts following the corporate forecast an 18-20% EPS enhance for each 2024 and 2025 – however simply how seemingly is that primarily based on historic accuracy statistics?

I do not usually say “Nah” however… nah, not for my part.

These aren’t stats I might be prepared to hold my hat on, even much less make investments cash in. There are various protection contractors at present buying and selling at way more engaging multiples and upsides whereas offering a lot better yields. Verify RTX, for one.

Given the shortage of transparency and certainty on this sector, I’d warning anybody from shopping for SAAB above a 400-450 SEK value. The corporate now trades at 547 SEK native. S&P World analysts give the corporate a spread beginning at 605 SEK and going all the best way as much as 735 SEK. I am the odd man out right here, going as little as the vary of 400-450 SEK. Nonetheless, solely 4 analysts comply with the corporate, and solely 50% of these have a “BUY” ranking on the corporate, regardless of a supposed 21.8% upside to a median share value of 667 SEK/share. In order that appears to me to point an absence of conviction regardless of these lofty costs and official expectations.

To search out extra rational expectations, we are able to put the corporate in a global context of Tangible e-book, FCF projections, P/S numbers, Graham, and DCF modeling. A conservative-based earnings-based DCF with a double-digit low cost involves 272-354 SEK, relying in your progress fee assumptions. A P/S comparability to the sector places the corporate just under 400 SEK, at round 380 SEK. It doesn’t matter what comparability you make, you have a tendency to search out your self on the 350-420 SEK mark, or thereabouts – and that is additionally why I am placing my value goal at 420 SEK/share – no extra.

I totally understand that the market might proceed to assign SAAB a excessive a number of associated to the present tendencies in protection. Additional backlog and orders might enhance this additional. However that is all too shaky a basis for me to construct a long-term place upon.

I will not pay above 20-22x P/E for this firm – not ever. What I’ve as a substitute tried doing is to see if by way of the strategic use of buy-write CCs, I might garner double-digit RoR on the extent that I’m in search of – in layman’s phrases, going lengthy SAAB and promoting longer-expiration, deep ITM places and making an attempt to garner returns from the extrinsic worth. For such performs – or for the reverse, being CSPs, I normally demand between an 11-15% annualized RoR, on the minimal.

As of but, I’ve been unable to search out such performs working, however I proceed to search for them as I transfer into the market. As I’ve stated, I’d be completely prepared to personal the corporate at 420 – so if I can discover CCs that correspond to that and the place I am being paid a good premium for my danger, I might be prepared to go there.

However straight shopping for at 500+ SEK?

No, that is not one thing I am prepared to do.

I stay not directly invested in SAAB by way of Investor AB, certainly one of my largest Swedish particular person positions of over 4%, and I’ve no plans to do something with this place.

However direct investments in SAAB ought to come provided that you get the corporate at a superb value, which I don’t view as attainable presently.

I will let you realize if and when this adjustments.

This is my present thesis for SAAB.

Thesis

• SAAB is Sweden’s largest protection contractor, and a storied a part of our historical past, establishing among the finest navy merchandise Sweden provides. I view it as a wonderful firm with an important upside – if you happen to purchase it on the proper value.
• The fitting value, for my part, is someplace alongside the 380-420 SEK mark, with a most acceptable PT of round 420 SEK – and the corporate is at present removed from this. There are strategies for investing the place we might go into SAAB, however these strategies, comparable to buy-writes, don’t at present supply the form of annualized return profile that might set them other than lower-risk investments with higher yields.
• For that cause, I think about SAAB to be a weak prospect right here, and I’d say that it warrants not more than a “HOLD” right here.

Bear in mind, I am all about:

• Shopping for undervalued – even when that undervaluation is slight and never mind-numbingly huge – firms at a reduction, permitting them to normalize over time and harvesting capital features and dividends within the meantime.
• If the corporate goes nicely past normalization and goes into overvaluation, I harvest features and rotate my place into different undervalued shares, repeating #1.
• If the corporate would not go into overvaluation however hovers inside a good worth, or goes again right down to undervaluation, I purchase extra as time permits.
• I reinvest proceeds from dividends, financial savings from work, or different money inflows as laid out in #1.

Listed below are my standards and the way the corporate fulfills them (italicized).

• This firm is general qualitative.
• This firm is basically secure/conservative & well-run.
• This firm pays a well-covered dividend.
• This firm is at present low-cost.
• This firm has a sensible upside that’s excessive sufficient, primarily based on earnings progress or a number of growth/reversion.

Neither low-cost or with an upside, I think about the corporate at present one to keep away from, and assign it a “HOLD” ranking right here.

Editor’s Notice: This text discusses a number of securities that don’t commerce on a serious U.S. trade. Please pay attention to the dangers related to these shares.