W5 Solutions: Softer near-term outlook, longer-term remains strong

Research Update

2024-02-26

07:54

Redeye updates on W5 Solutions after its Q4-results which were lower than expected, partly due to the normal low predictability of quarterly sales owing to the nature of the business model. However, order intake was also soft and while the company is optimistic about potential new orders in the coming six months, we have lowered our short-term organic growth expectations. Still, looking into 2025-26E we expect continued strong growth and with long-term forecasts we make limited changes to our valuation range.

Hjalmar Ahlberg

John Westborg

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Q4-results below expectations

W5’s Q4-results were weaker than expected with both topline and profitability coming in below our estimates. The company experienced delays in the quarter which also impacted costs. However, we highlight that W5’s quarterly results are unpredictable, where for example Q2 and Q3 were much better than expected.

Softer near-term outlook, long-term remains strong

Coming to the outlook, the long-term potential remains solid with continued strong demand driven by growing defense spending. However, the order intake in Q4 was soft and while the company sees potential for an increased order book in the next six months, we have lowered our near-term organic growth estimates.

Lowered estimates and valuation range

On the back of lower near-term organic growth expectations we have lowered our 2024-25E topline estimates with 6-8% and our EBITDA estimates with 9-15%. We also lower our valuation range where the new base case is SEK100 (SEK107) which implies c17x EBITDA 2024E and 13x EBITDA 2025E.

Key financials

SEKm	2022	2023	2024e	2025e	2026e
Revenues	176.0	387.0	511.5	626.6	751.9
Revenue Growth	23.9%	120%	32.2%	22.5%	20.0%
EBITDA	24.4	56.0	80.8	103.2	123.9
EBITA	19.9	47.9	70.8	93.2	111.9
EBIT	17.6	4.8	10.8	33.2	51.9
Net Income	13.7	-1.3	4.3	24.9	38.9
EV/Sales	3.9	3.5	2.9	2.3	1.8
EV/EBITDA	28.1	24.2	18.2	13.8	11.1
EV/EBIT	39.1	283	137	43.0	26.5

Q4-results below expectations

W5 reported net sales of SEK128m and EBITDA of SEK11m for Q4 2023, which was below our forecast of SEK140m and SEK27m respectively. While the results were lower than expected, we highlight that the company’s quarterly results are variable with unpredictable deliveries and that the two previous quarters were stronger than expected. The company commented that it experienced delays during the quarter which also impacted on costs. Still, gross margin was 56% which was close to our forecast of 58% and staff costs were in line with expectations while other opex was higher than expected. On the positive side, the company saw strong operating cash flow of SEK61m during the quarter, driven by changes in working capital. W5 ended the quarter with cash of SEK35m while total debt was SEK36m. The table below summarizes Q4-results outcome compared to our forecasts.

W5 Solutions results outcome
SEKm	Q4 22	Q1 23	Q2 23	Q3 23	Q4 23E	Q4 23A	Diff, %
Net Sales	78.1	71.0	112.0	75.8	139.8	128.2	-8%
Growth Y/Y (%)	42.4%	109.2%	189.5%	200.6%	79.0%	64.1%

COGS	-47.7	-29.7	-44.1	-30.7	-58.7	-57.0	-3%
Personnel costs	-15.5	-19.1	-28.9	-22.4	-36.1	-36.7	2%
Other costs	-6.0	-11.1	-16.5	-17.3	-18.0	-23.9	33%

EBITDA	9.3	11.8	24.7	8.0	27.0	11.4	-58%
EBITDA (%)	11.9%	16.6%	22.1%	10.6%	19.3%	8.9%

D&A	-2.2	-4.0	-16.1	-12.4	-17.0	-18.7	10%

EBIT	7.1	7.8	8.6	-4.4	10.0	-7.3	n.m.
EBIT %	9.1%	11.0%	7.7%	-5.8%	7.1%	-5.7%

Net income	5.3	5.5	5.9	-4.8	6.7	-8.2	n.m.

EPS adj, SEK	0.42	0.42	0.44	-0.35	0.45	-0.05	n.m.

Source: Redeye Research

Softer near-term outlook, long-term remains strong

W5 saw an order intake of SEK82m in Q4 2023 and the order book stood at SEK199m at the end of 2023. W5 comments that while the order intake was slightly weak in Q4, it expects several business decisions from customers in the next six months while adding that market demand remains strong. As such, there is potential to increase the order book in the coming months, however with long lead times from order to delivery there is risk that new orders will delivered in 2025 rather 2024. As illustrated in the chart below, revenues have been running higher than order intake. On the back of the soft order intake in Q4, we have lowered our expectations for organic growth in the next couple of quarters, however, there could be upside to our estimates if large orders are announced in the next few months.

W5 order book and order intake R12m

Source: Redeye Research

Lowered estimates for 2024-25E

On the back of the soft order intake in Q4 2023, we have lowered our topline forecasts for 2024-25E by 6-8% while EBITDA estimates are reduced by 9-15%. We now forecast revenue of SEK512m for 2024E, representing growth of 32% vs 2023 of which 13% is organic. Our forecast still implies that W5 will achieve its 2025 topline target of SEK500m already in 2024. The company did not announce any changes to the financial targets in connection with the report. However, we still see potential for upgraded targets which potentially could come later in the year after the CEO, Evelina Hedskog, has taken office (due to start 1 March). The tables below summarizes key financials for 2022-26E.

W5 Solutions: Group financials 2022-26E
SEKm	2022	2023	Q1 24E	Q2 24E	Q3 24E	Q4 24E	2024E	2025E	2026E
Revenue	176	387	104	138	110	160	512	627	752
Growth Y/Y (%)	24%	120%	46%	23%	45%	25%	32%	23%	20%

COGS	-81	-161	-44	-58	-46	-67	-215	-263	-316
Gross profit	95	226	60	80	64	93	297	363	436
Gross margin, %	54%	58%	58%	58%	58%	58%	58%	58%	58%

Personnel costs	-51	-107	-37	-38	-37	-39	-151	-179	-214
Other costs	-23	-71	-15	-18	-13	-20	-65	-81	-98

EBITDA adj	24	56	8	25	14	34	81	103	124
EBITDA adj (%)	14%	14%	8%	18%	13%	21%	16%	16%	16%

Non-recurring	0	0	0	0	0	0	0	0	0

EBITDA	24	56	8	25	14	34	81	103	124
EBITDA (%)	14%	14%	8%	18%	13%	21%	16%	16%	16%

D&A	-7	-51	-18	-18	-18	-18	-70	-70	-72
OW amortisation	-2	-43	-15	-15	-15	-15	-60	-60	-60

EBITA	20	48	5	22	12	31	71	93	112
EBITA (%)	11%	12%	5%	16%	11%	20%	14%	15%	15%

EBIT	18	5	-10	7	-3	16	11	33	52
EBIT (%)	10%	1%	-9%	5%	-3%	10%	2%	5%	7%

Net income	14	-1	-9	5	-3	11	4	25	39

EPS reported, SEK	1.1	-0.1	-0.6	0.3	-0.2	0.8	0.3	1.7	2.6
EPS ex. amortization	1.2	2.1	0.2	1.1	0.5	1.5	3.3	4.7	5.6

Source: Redeye Research

Valuation

While we lower our 2024-25E EBITDA with 10-15%, our longer-term growth and profitability forecasts are unchanged. As such, the impact on our valuation range is more limited, although we still lower our base case to SEK100 (SEK107) while the new bull case is SEK180 (SEK185) and bear case is SEK51 (SEK55). Our base case implies c17x EBITDA 2024E and 13x EBITDA 2025E. The table below summarizes key financial assumptions for our valuation scenarios.

W5 Solutions: Fair Value Range
SEK	Bear Case	Base Case	Bull Case

Value per share	51	100	180
OW M&A upside	14	24	37

Revenue CAGR 2025-2029	12%	17%	22%
Revenue CAGR 2030-2039	8%	10%	13%
Growth Terminal	2%	2%	2%

EBITDA-margin 2025-2039	14%	17%	19%
EBITDA-margin terminal	13%	15%	18%

Source: Redeye Research

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 2023-25E and believe the company will complement this growth with acquisitions. The company has seen stronger-than-expected growth in 2023 driven by solid organic growth and acquisitions. On the back of this, we believe W5 looks set to achieve its 2025 revenue target of SEK500m already by 2024. We expect profitability to remain in line with the company’s target to achieve a 15 percent EBITA margin, while there could be upside potential as W5 is likely to see 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 SEK100 in our base case which implies a multiple of 17x EBITDA 2024E and 13x EBITDA 2025E. Our valuation also includes upside potential from M&A depending on the valuation multiple for future acquisitions (we assume a range of 5-10x EBIT). The average for the range is SEK24 per share, which we include as M&A upside our base case.

Quality Rating

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.

Financials

Income statement
SEKm	2022	2023	2024e	2025e	2026e
Revenues	176.0	387.0	511.5	626.6	751.9
Cost of Revenue	81.3	161.4	214.8	263.2	315.8
Operating Expenses	70.3	169.6	215.9	260.2	312.2
EBITDA	24.4	56.0	80.8	103.2	123.9
Depreciation	4.5	8.0	10.0	10.0	12.0
Amortizations	2.4	43.2	60.0	60.0	60.0
EBIT	17.6	4.8	10.8	33.2	51.9
Shares in Associates	0.00	0.00	0.00	0.00	0.00
Interest Expenses	0.59	2.2	5.0	0.00	0.00
Net Financial Items	-0.61	-1.4	-5.0	0.00	0.00
EBT	16.9	3.3	5.8	33.2	51.9
Income Tax Expenses	3.2	4.6	1.4	8.3	13.0
Net Income	13.7	-1.3	4.3	24.9	38.9
Balance sheet
Assets
Non-current assets
SEKm	2022	2023	2024e	2025e	2026e
Property, Plant and Equipment (Net)	7.6	13.4	14.4	15.4	16.6
Goodwill	20.1	228.2	192.2	156.2	120.2
Intangible Assets	8.1	107.0	88.1	76.6	67.7
Right-of-Use Assets	0.00	0.00	0.00	0.00	0.00
Other Non-Current Assets	0.56	0.89	0.89	0.89	0.89
Total Non-Current Assets	36.3	349.5	295.6	249.1	205.3
Current assets
SEKm	2022	2023	2024e	2025e	2026e
Inventories	43.6	83.8	102.3	125.3	150.4
Accounts Receivable	96.7	78.9	102.3	125.3	150.4
Other Current Assets	13.8	34.9	25.6	31.3	37.6
Cash Equivalents	48.0	35.2	67.3	109.9	161.2
Total Current Assets	202.2	232.9	297.5	391.9	499.6
Total Assets	238.5	582.4	593.0	641.0	704.9
Equity and Liabilities
Equity
SEKm	2022	2023	2024e	2025e	2026e
Non Controlling Interest	0.00	0.00	0.00	0.00	0.00
Shareholder's Equity	143.1	304.9	309.2	334.2	373.1
Non-current liabilities
SEKm	2022	2023	2024e	2025e	2026e
Long Term Debt	3.7	26.8	26.8	26.8	26.8
Long Term Lease Liabilities	0.00	0.00	0.00	0.00	0.00
Other Long Term Liabilities	7.1	87.5	87.5	87.5	87.5
Total Non-Current Liabilities	10.9	114.3	114.3	114.3	114.3
Current liabilities
SEKm	2022	2023	2024e	2025e	2026e
Short Term Debt	1.7	19.3	19.3	19.3	19.3
Short Term Lease Liabilities	0.00	0.00	0.00	0.00	0.00
Accounts Payable	20.5	23.5	51.2	62.7	75.2
Other Current Liabilities	62.4	120.3	99.0	110.5	123.1
Total Current Liabilities	84.6	163.1	169.5	192.5	217.5
Total Liabilities and Equity	238.5	582.4	593.0	641.0	704.9
Cash flow
SEKm	2022	2023	2024e	2025e	2026e
Operating Cash Flow	-40.9	89.4	48.2	66.2	79.6
Investing Cash Flow	-29.4	-282.6	-16.1	-23.5	-28.2
Financing Cash Flow	64.9	180.4	0.00	0.00	0.00

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