EUR 850.00 For Business Accounts Only

Morningstar | LDO Updated Forecasts and Estimates from 14 Sep 2018

After publication of decent second-quarter 2018 results, we maintain our EUR 12 fair value estimate and no-moat rating for Leonardo. We continue to believe Leonardo shares are undervalued and offer investors attractively priced exposure to increasing defense budgets and recovery of helicopter markets. The firm recorded revenue of EUR 3.1 billion (flat year on year), as lower deliveries of new helicopters were offset by strong volume growth in the U.S. of the firm's electronics, defence & security, or EDS, division (revenue up 4%). In the second quarter, 48 helicopters were delivered to end customers compared with 69 in the year-ago quarter--in our view, a robust achievement as the firm was faced with a higher base of comparison regarding deliveries of new helicopters. In 2017, due to production issues, delivery of various units was postponed from first quarter to second quarter. Strong production activity continued in July 2018 (we estimate deliveries to be approximately 23 versus three helicopters in July 2017), supporting our view of full-year deliveries in excess of 160 (149 in 2017).

Leonardo's EBITA margin in the quarter declined 110 basis points as efficiency improvements at EDS (EBITA margin up 70 basis points) were more than offset by lower margin activity at helicopters. Although we believe appropriate actions have been taken to address the production issues, we still think a significant part of Leonardo's helicopter division order backlog of EUR 9.3 billion at the end of June 2018 contains low-margin orders where far too much flexibility on configurations were agreed by commercial teams chasing sales in challenging civil and military helicopter markets. We expect Helicopter division's EBITA margin to be back to double-digit levels in 2020 (versus 8.4% in first-half 2018) due to the phasing out of low-margin contracts, increased production flexibility and higher deliveries for high end helicopters, AW139 and AW189.

In the first six months of 2018, Leonardo's aeronautics EBITA margin declined 30 basis points, but we expect profitability increases in the remainder of 2018 and beyond. Our forecast aeronautics margin improvement (about 150 basis point in our five-year forecast period) is mainly attributable to an improvement in the performance of both the aircraft segment (greater volumes due to a EUR 7.95 billion EFA-Kuwait contract win in 2016) and the aerostructures segment (process improvement, higher deliveries of fuselage sections of Boeing successful widebody 787 programme and cost-cutting to compensate for reduction in the production rates of the ATR and A380 programmes).