Leonardo DRS (DRS), a leading provider of defence products and technologies, presents a compelling investment opportunity within the broader aerospace and defence sector. The company’s entrenched position within key U.S. defence programmes, coupled with favourable secular trends and robust financials, supports a positive outlook.
Executive Summary
Leonardo DRS is poised to benefit from increased defence spending, particularly in areas like naval modernisation and electronic warfare, where the company possesses significant expertise. DRS’s strong financial performance, including consistent revenue growth and healthy margins, further solidifies its attractiveness as an investment.
Industry Overview
The global defence market is experiencing a period of expansion, driven by rising geopolitical uncertainties and a renewed focus on military readiness. Global military expenditure reached over $2 trillion for the first time in 2022, highlighting the upward trajectory of defence budgets worldwide. This backdrop creates a fertile ground for companies like Leonardo DRS, which specialises in mission-critical technologies.
Company Analysis
Leonardo DRS operates through five key segments: Advanced Sensing, Network Computing & Software, Integrated Mission Systems, Electric Power & Propulsion Systems and Space & C4ISR Solutions. The company holds a leading market share in several niche areas, such as naval power systems and electro-optical/infrared systems, benefiting from high barriers to entry and long product lifecycles. Its customer base primarily comprises the U.S. Department of Defence and allied governments, providing a stable and predictable revenue stream.
DRS boasts a robust financial profile. Its recent financial performance showcases strong revenue growth and expanding profit margins. This financial strength is further bolstered by a substantial backlog of orders, indicating continued momentum in the near term.
Investment Thesis
Our investment thesis for Leonardo DRS rests on three pillars:
- Beneficiary of Rising Defence Spending: The current geopolitical climate supports sustained growth in defence budgets globally, directly benefiting companies like DRS with exposure to key spending priorities.
- Technological Leadership and Market Dominance: DRS’s expertise in niche areas like naval power systems and electro-optical systems provides a significant competitive advantage, creating a “moat” against competitors and ensuring long-term relevance.
- Strong Financials and Compelling Valuation: DRS’s consistent revenue growth, healthy margins, and strong cash flow generation create a compelling investment case, particularly when compared to its industry peers.
Valuation & Forecasts
We employed a combination of valuation methodologies to assess Leonardo DRS’s intrinsic value, including discounted cash flow (DCF) analysis, comparable company analysis, and precedent transaction analysis. Our base-case DCF model, assuming a weighted average cost of capital (WACC) of 8% and a terminal growth rate of 3%, yields a target price of $42 per share.
| Valuation Method | Target Price |
|---|---|
| DCF (Base Case) | $42 |
| Comparable Company Analysis | $40 |
| Precedent Transaction Analysis | $45 |
Our forecasts for key financial metrics over the next three years project continued revenue growth and margin expansion, driven by strong demand for DRS’s products and services.
Risks
While we are positive on the long-term outlook for DRS, we acknowledge potential risks that could impact the company’s performance. These include:
- Defence Spending Cuts: Potential reductions in defence budgets could negatively impact DRS’s revenue and profitability.
- Program Execution Risks: Delays or cost overruns in key defence programmes could affect DRS’s financial performance.
- Competition: Increased competition from other defence contractors could pressure DRS’s market share and margins.
Recommendation
Based on our analysis, we recommend a Buy rating for Leonardo DRS with a 12-month price target of $42. We believe the company is well-positioned to capitalise on the favourable trends in the defence industry, and its strong fundamentals and compelling valuation offer investors an attractive entry point.
