W5 Solutions: Strong order intake supports positive outlook

Research Update

2022-12-23

08:06

Redeye updates estimates and valuation on W5 solutions following a solid Q3-report and a continued strong order intake as well as an expansion into Finland. Overall, the outlook remains positive and we have slightly raised our 2023-24E estimates while we also trim 2022E due to continued supply chain uncertainty in the near-term.

HA

JW

Hjalmar Ahlberg

John Westborg

Solid Q3-report

W5 reported solid Q3-numbers where revenue was in line with our expectations while profit was above our forecast owing to a strong gross margin and lower opex than estimated. The company also gave a positive outlook for the year-end while also highlighting short-term uncertainty due to continued supply chain challenges.

Strong order intake and expansion into Finland

W5 continued to build its order book during Q3 2022 and at the end of the quarter it stood at SEK217m compared to SEK142m in Q3 2021. Order intake has also continued to be strong during Q4 2022 with announced orders of around SEK54m in December while the company commented in its Q3-report that it expects a continued strong order intake in 2023. Furthermore, the announced expansion into Finland creates additional growth potential over the coming years.

Outlook remains positive

Overall, we continue to see strong growth potential for W5 in the coming years driven by expansion into new segments, products and markets coupled with support from growing defense budgets. While we have trimmed our revenue estimates for Q4 due to continued supply chain challenges, we also raise our 2023-24E forecasts slightly on the back of the positive outlook in the Q3-report coupled with the announced orders during Q4 2022. Although our estimates are increased for 2023-24E, our valuation range is slightly lowered as we have raised our risk-free rate assumptions and our new base case stands at SEK70 (SEK74).

SEKm202020212022e2023e2024e
Revenues114.0142.0172.9244.0292.9
Revenue Growth97.9%24.5%21.8%41.2%20.0%
EBITDA10.324.732.543.352.7
EBITA9.722.126.837.344.7
Net Income5.313.419.126.231.7
EV/EBITDA24.019.116.511.48.9
EV/EBIT25.521.321.714.111.0
P/E47.026.233.124.119.9

Solid Q3-report

W5 reported revenue of SEK25.5m for Q3 2022 (excluding activated work of SEK2.1m) which was slightly above our forecast of SEK25.0m. With a strong gross margin of 72% (we estimated 60%) and slightly lower opex than expected the reported EBITDA of SEK2.9m was above our estimated negative EBITDA of SEK1.0m. However, Q3 is a seasonally small quarter for the company and as such it only has a small impact on our full-year estimates. Still, the company comments that it expects to deliver around SEK70m or its order book during Q4 and as such we have slightly trimmed our expectations for Q4 where we now expect revenue of SEK75m (previous SEK85m).

Strong order intake and expansion into Finland

Looking into 2023-24E the growth outlook remains positive as W5 has continued to build its order book which stood at SEK217m in Q3 2022 compared to SEK142m in Q3 2021. During Q4, the company has announced orders totalling SEK54m (excluding the Archer artillery system simulator cabin where the order value has not been disclosed) suggesting potential for continued increase of the order book. Additionally, growth is supported by the expansion into Finland which will quickly yield revenue contribution through an asset acquisition of a skeet trap systems operation that is expected to yield annual sales of EUR400k (cSEK4m).

Key financials

Overall, we make limited changes to our forecasts, although we have trimmed our Q4 2022 revenue expectations as supply chains remain challenging. However, we also increase our 2023-24E forecasts somewhat on the back of the recent strong order intake coupled with the company's positive commentary on the outlook for 2023E and the abovementioned expansion into Finland. In summary, our 2022E EBITDA is down c. 4% while 2023-24E is increased with 2%.

Valuation

We have slightly lowered our valuation range on the back of increased assumptions for the risk-free rate (new discount rate of 10.5% compared to previous 10.0%). Our new base case stands at SEK70 (SEK74) while the bull case stands at SEK100 (SEK106) and the bear case at SEK36 (SEK38).

All our scenarios include upside from M&A with a range of SEK10-30 per share depending on acquisition multiples of 5-10x EBIT and an assumed available capital of SEK150m which includes 10% equity dilution. We use the average of SEK17 per share for our base case while we use the high-end of SEK30 per share for the bull case and low-end of SEK10 per share for the bear case.

The table below summarize the key assumptions for our three DCF-scenarios.

Bear case SEK36 (SEK38)Base case SEK70 (SEK74)Bull case SEK100 (SEK106)
Our bear case assumes organic growth of 8% in 2023-37E which assumes W5 sees limited success with its expansions and most revenue derived from Sweden. Terminal growth is 2% from 2037.Our base assumes organic growth of 12% in 2023-27E driven by mainly by successful expansion into new regions and partly by new segments and products. Terminal growth is 2% from 2037.Our bull assumes organic growth of 14% in 2023-37E driven by successful expansion of new regions as well as strong growth in new segments and successful new product additions. Terminal growth is 2% from 2037.
We assume an EBITDA-margin of 14% over the forecast period and 13% for the terminal period.We assume an EBITDA-margin of 17% over the forecast period and 15% for the terminal period.We assume an EBITDA-margin of 19% over the forecast period and 18% for the terminal period.
The bear case includes M&A upside of SEK10 per share.The base case includes M&A upside of SEK17 per share.The bull case includes M&A upside of SEK30 per share.

Investment thesis

Case

Attractive growth potential with M&A optionality

Redeye expects W5 to show continued growth over the coming years as it benefits from growing demand for defense training and simulation bolstered by expansion into new regions and customer segments, and new product development. We expect revenue growth of 20 percent organically in 2022-25E and believe the company will complement this growth with acquisitions. All in all, we believe W5 will achieve its revenue target of SEK500m by 2025 (it reported SEK139m in revenues in 2021). We also expect profitability to improve in line with the company’s target to achieve a 15 percent EBITA margin (2021 EBIT-margin was 11 percent) as W5 is likely to see ongoing benefits of scale.

Evidence

Extensive history, high barriers to entry, and strong partnerships

W5 has an extensive history in the defense industry and its solid management team holds core expertise in simulation and training, growing niches with limited competition from the major defense contractors. The defense industry has high barriers of entry, which, together with long-term contracts, render high revenue visibility. W5 can also lever on its several major partnerships, including with Saab, L3Harris, Lockheed Martin, and KMW.

Challenge

Limited M&A experience, risk through geographical expansion, and production capacity

The main challenges we see for W5 are its geographical expansion into new markets and M&A. Breaking into new markets could be challenging, but W5’s partnerships with larger players reduce this risk. While W5 has limited M&A experience, the merger of the companies to create W5 has been a success. Furthermore, a decentralized approach to acquisitions typically reduces the M&A risk. W5 could also face capacity challenges that could limit its growth if the company cannot produce to meet growing demand. Given a focus on complementary M&A, acquisitions could ease this challenge.

Valuation

Valuation based on DCF and upside optionality from M&A

On the back of a DCF-valuation we derive a fair value of SEK70 in our base case which implies a multiple of 25x EBIT 2023E. Our valuation also includes upside potential from M&A where we see an upside range of SEK10-30 per share depending on the valuation multiple for future acquisitions (we assume a range of 5-10x EBIT). The average for the range is SEK17 per share which we include as M&A upside our base case while we use the high-end of SEK30 per share for the bull case and low-end of SEK10 per share for the bear case.

Summary Redeye Ratings

The rating consists of three valuation keys, each consituting an overall assesment of several factors that are rated on a scale of 0 to 1 points. The maximum score for a valuation key is 5 points.

People: 4

Since the merger of W5 Systems, Teleanalys and MSE in 2018, the group has shown profitable growth whereas the individual companies struggled before the merger. The management and board of W5 Solutions consist mostly of the same people that led W5 Systems, Telenalys and MSE before the merger which we argue is good for W5 and brings insight on all different aspects of the company’s businesses. With the solid profitable growth since 2019 and the focus on partnerships, M&A and a strong presence in W5’s home markets we would say that the management has proven itself. The management and board are also large investors in W5 through the holding companies Swedish Defense Group AB, DT2W Invest AB and MSE Holding AB.

Business: 4

The defense training and simulation market is bound by long contracts and high barriers of entry, giving W5 a strong market position in its home market Sweden. Through partnerships and a strategic M&A focus, W5 is in a good position for growth in both its home market and new geographic regions and market segments. One integral driver in the defense market is the uncertain geopolitical state of the world which requires increased spending on defense. With a ramp up of defense budgets, W5 is in a great position to expand its business.

Financials: 3

While W5 has seen strong financial performance since its foundation in 2018, the company’s history is short which has a negative impact on the financial rating score. With long contracts the business model yields good visibility and solid cash flow with limited investment needs as product development is typically financed by customers. The company has a strong financial position which provides a good position to pursue its M&A ambitions.

Income Statement

Income statement
SEKm202020212022e2023e2024e
Revenues114.0142.0172.9244.0292.9
Cost of Revenue60.063.666.9107.4128.9
Operating Expenses43.753.773.493.3111.3
EBITDA10.324.732.543.352.7
Depreciation0.612.65.86.08.0
Amortizations0.000.002.02.42.4
EBIT9.722.124.734.942.3
Shares in Associates0.000.000.000.000.00
Interest Expenses0.600.580.450.000.00
Net Financial Items-0.60-0.35-0.530.000.00
EBT9.115.324.234.942.3
Income Tax Expenses3.81.95.18.710.6
Net Income5.313.419.126.231.7

Balance Sheet

Balance sheet
Assets
Non-current assets
SEKm202020212022e2023e2024e
Property, Plant and Equipment (Net)4.24.64.14.75.5
Goodwill0.000.000.000.000.00
Intangible Assets0.789.529.427.024.6
Right-of-Use Assets0.000.000.000.000.00
Other Non-Current Assets0.721.11.11.11.1
Total Non-Current Assets5.715.234.732.931.3
Current assets
SEKm202020212022e2023e2024e
Inventories7.623.534.648.858.6
Accounts Receivable7.444.651.948.858.6
Other Current Assets19.07.58.612.214.6
Cash Equivalents7.853.4100.0143.2169.2
Total Current Assets41.8129.0195.1253.1301.0
Total Assets47.5144.2229.7285.9332.3
Equity and Liabilities
Equity
SEKm202020212022e2023e2024e
Non Controlling Interest0.000.000.000.000.00
Shareholder's Equity20.364.8148.9175.1206.8
Non-current liabilities
SEKm202020212022e2023e2024e
Long Term Debt4.43.73.73.73.7
Long Term Lease Liabilities0.000.000.000.000.00
Other Non-Current Lease Liabilities3.16.36.36.36.3
Total Non-Current Liabilities7.510.010.010.010.0
Current liabilities
SEKm202020212022e2023e2024e
Short Term Debt0.530.820.820.820.82
Short Term Lease Liabilities0.000.000.000.000.00
Accounts Payable5.625.825.948.858.6
Other Current Liabilities13.642.944.251.356.2
Total Current Liabilities19.769.570.9100.9115.5
Total Liabilities and Equity47.5144.2229.7285.9332.3

Cash Flow

Cash flow
SEKm202020212022e2023e2024e
Operating Cash Flow7.117.68.849.934.8
Investing Cash Flow-0.87-1.3-27.2-6.6-8.8
Financing Cash Flow-0.9029.265.00.000.00

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