W5 Solutions: Improving order outlook

Research Update

2024-05-06

07:30

Analyst Q&A

Closed

Hjalmar Ahlberg answered 2 questions.

Redeye updates on W5 following its Q1-results which came in slightly below our forecasts. Order intake was stable in Q1, and the company has seen an improvement during Q2 which supports our outlook for a stronger H2 2024. Still, we lower our near-term growth assumptions and our 2024-26E EBITDA estimates are down 9-12%.

Hjalmar Ahlberg

John Westborg

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Q1 results close to forecast

W5’s Q1-results came in slightly lower than expected with sales coming at SEK95m and EBITDA at SEK4.4m compared to our forecasts of SEK104m and SEK7.9m, respectively. While profitability was weak, we emphasize that Q1 is a seasonally soft quarter and that we expect stronger profitability for the rest of the year.

Improving order outlook

W5’s saw an order intake of SEK75m in Q1, and the order book stood at SEK202m at the end of the quarter. Looking into Q2 and the rest of the year, the company has seen announced two large orders in April while adding that it expects a continued positive trend for the rest of the year.

Lowered estimates and valuation range

While the order outlook is improving, we adopt a slightly more cautious near-term outlook until we see growth in the order book. We lower our topline forecasts by around 9% for 2024-26E while EBITDA estimates are lowered by 9-12%. On the back of the estimate changes, we also lower our valuation range where the new base case stands at SEK93 (SEK100). The share currently trades at c15x 2024E EBITDA while our base case implies 18x 2024E EBITDA.

Key financials

SEKm	2022	2023	2024e	2025e	2026e
Revenues	176.0	387.0	467.1	572.2	686.7
Revenue Growth	23.9%	120%	20.7%	22.5%	20.0%
EBITDA	24.4	56.0	71.3	93.8	113.2
EBITA	19.9	47.9	61.4	83.8	101.2
EBIT	17.6	4.8	21.4	43.8	61.2
EBIT Margin	10.0%	1.2%	4.6%	7.6%	8.9%
Net Income	13.7	-1.3	8.0	32.8	45.9
EV/Sales	3.9	3.5	2.2	1.8	1.4
EV/EBITDA	28.1	24.2	14.6	10.8	8.5
EV/EBIT	39.1	283	48.8	23.0	15.8

Q1-results close to forecasts

W5 reported net sales of SEK95m for Q1 2024, which was close to our forecast of SEK104m. This represents total growth of 34% where we estimate organic growth to be negative by around 20-25%. EBITDA came in at SEK4.4m while we estimated SEK7.9m. Gross margin came in at 58% which was largely in line with our estimate and the company’s historical levels. Overall opex was also as expected, albeit with somewhat lower personnel costs and higher other external costs. As usual, we highlight that W5’s numbers should be viewed on an annualized basis to reflect seasonality, where the first quarter is typically a soft quarter. Below, we illustrate the company’s revenue and EBITA development on an annualized basis as well as the outcome for Q1 2024 compared to our forecasts.

W5 Solutions results outcome
SEKm	Q1 23	Q2 23	Q3 23	Q4 23	Q1 24E	Q1 24A	Diff, %
Net Sales	71.0	112.0	75.8	128.2	103.9	95.0	-9%
Growth Y/Y (%)	109.2%	189.5%	200.6%	64.1%	46.3%	33.7%

COGS	-29.7	-44.1	-30.7	-57.0	-43.7	-40.7	-7%
Personnel costs	-19.1	-28.9	-22.4	-36.7	-37.4	-34.8	-7%
Other costs	-11.1	-16.5	-17.3	-25.8	-15.0	-17.2	14%

EBITDA	11.8	24.7	8.0	11.4	7.9	4.4	-44%
EBITDA (%)	16.6%	22.1%	10.6%	8.9%	7.6%	4.6%

D&A	-4.0	-16.1	-12.4	-18.7	-17.5	-12.5	-29%

EBIT	7.8	8.6	-4.4	-7.3	-9.6	-8.0	n.m.
EBIT %	11.0%	7.7%	-5.8%	-5.7%	-9.2%	-8.4%

Net income	5.5	5.9	-4.8	-7.9	-8.7	-11.8	n.m.

EPS, SEK	0.42	0.44	-0.35	-0.53	-0.58	-0.79	n.m.

Source: Redeye Research

W5 revenue and EBITA, R12m

Source: Redeye Research

Improving order outlook

W5’s order book stood at SEK202m at the end of the quarter, which was unchanged compared to SEK199m in Q4 2023. The company reported an order intake of SEK75m supported by a solid flow of smaller orders while no larger order was announced during the quarter. W5 comments that its product mix has changed after the acquisitions carried out in 2023, and the lead time from order to delivery has become shorter. In April, the company announced two new orders in the live fire segment totalling SEK92m (of which 60m is a framework agreement) suggesting potential for a growing order book in Q2 2024. Looking forward, the company further states that it has seen a strong order intake after the end of Q1 and it expects a positive trend for the rest of the year. The company also mentions that it received its first orders in battery manufacturing, which is a product where the company sees large potential.

W5 order book and order intake R12m

Source: Redeye Research

Estimates lowered by 9-12% for 2024-26E

While the order outlook is improving, we adopt a slightly more cautious near-term growth outlook until we see a higher reported order book. As such, we lower our topline forecasts by 9% for 2024-26E, where we now expect limited organic growth in 2024E (around 2%), owing to the soft order intake in late Q4 2023 and Q1 2024. Nevertheless, we still expect strong growth in 2025-26E, albeit from a lower base. We forecast organic growth of 23% in 2025 and 20% in 2026 and expect the company to achieve its target of above SEK500m in revenue by 2025E.

W5 Solutions: Group financials 2022-26E
SEKm	2022	2023	Q1 24	Q2 24E	Q3 24E	Q4 24E	2024E	2025E	2026E
Net Sales	176	387	95	126	98	147	467	572	687
Growth Y/Y (%)	24%	120%	34%	13%	30%	15%	21%	23%	20%

COGS	-81	-161	-41	-53	-41	-62	-197	-240	-288
Gross profit	95	226	54	73	57	85	270	332	398
Gross margin, %	54%	58%	57%	58%	58%	58%	58%	58%	58%

Personnel costs	-51	-107	-35	-35	-32	-37	-139	-168	-202
Other costs	-23	-71	-17	-18	-13	-18	-65	-74	-88

EBITDA adj	24	56	4	22	14	32	71	94	113
EBITDA adj (%)	14%	14%	5%	17%	14%	21%	15%	16%	16%

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

EBITDA	24	56	4	22	14	32	71	94	113
EBITDA (%)	14%	14%	5%	17%	14%	21%	15%	16%	16%

D&A	-7	-51	-12	-13	-13	-13	-50	-50	-52
OW amortisation	-2	-43	-10	-10	-10	-10	-40	-40	-40

EBITA	20	48	2	19	11	29	61	84	101
EBITA (%)	11%	12%	2%	15%	11%	20%	13%	15%	15%

EBIT	18	5	-8	9	1	19	21	44	61
EBIT (%)	10%	1%	-8%	7%	1%	13%	5%	8%	9%

Net income	14	-1	-12	6	0	14	8	33	46

EPS reported, SEK	1.1	-0.1	-0.8	0.4	0.0	0.9	0.5	2.2	3.0
EPS ex. amortization	1.2	2.1	-0.3	0.9	0.5	1.4	2.5	4.1	5.0

Source: Redeye Research

Valuation

We have adjusted our valuation range on the back of the lowered estimates. Our new base case stands at SEK93 (SEK100) while the new bull case is SEK170 (SEK180) and the bear case is SEK50 (SEK51). The share currently trades at c15x 2024E EBITDA while our base case implies 18x 2024E EBITDA. The table below summarizes key assumptions for the valuation scenarios.

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

Value per share	50	93	170
OW M&A upside	10	17	27

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 SEK93 in our base case which implies a multiple of 18x EBITDA 2024E and 14x 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 SEK17 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	467.1	572.2	686.7
Cost of Revenue	81.3	161.4	197.0	240.3	288.4
Operating Expenses	70.3	169.6	198.8	238.1	285.1
EBITDA	24.4	56.0	71.3	93.8	113.2
Depreciation	4.5	8.0	9.9	10.0	12.0
Amortizations	2.4	43.2	40.0	40.0	40.0
EBIT	17.6	4.8	21.4	43.8	61.2
Shares in Associates	0.00	0.00	0.00	0.00	0.00
Interest Expenses	0.59	2.2	6.2	0.00	0.00
Net Financial Items	-0.61	-1.4	-5.9	0.00	0.00
EBT	16.9	3.3	15.4	43.8	61.2
Income Tax Expenses	3.2	4.6	7.5	10.9	15.3
Net Income	13.7	-1.3	8.0	32.8	45.9
Balance sheet
Assets
Non-current assets
SEKm	2022	2023	2024e	2025e	2026e
Property, Plant and Equipment (Net)	7.6	13.4	13.4	14.4	15.6
Goodwill	20.1	228.2	204.1	180.1	156.1
Intangible Assets	8.1	107.0	95.1	90.6	88.3
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	313.5	285.9	260.9
Current assets
SEKm	2022	2023	2024e	2025e	2026e
Inventories	43.6	83.8	93.4	114.4	137.3
Accounts Receivable	96.7	78.9	93.4	114.4	137.3
Other Current Assets	13.8	34.9	23.4	28.6	34.3
Cash Equivalents	48.0	35.2	64.1	98.2	140.6
Total Current Assets	202.2	232.9	274.3	355.7	449.6
Total Assets	238.5	582.4	587.8	641.7	710.5
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	312.9	345.7	391.6
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 Non-Current Lease 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	46.7	57.2	68.7
Other Current Liabilities	62.4	120.3	94.6	105.1	116.5
Total Current Liabilities	84.6	163.1	160.6	181.6	204.5
Total Liabilities and Equity	238.5	582.4	587.8	641.7	710.5
Cash flow
SEKm	2022	2023	2024e	2025e	2026e
Operating Cash Flow	-40.9	89.4	42.9	56.5	69.3
Investing Cash Flow	-29.4	-282.6	-14.0	-22.4	-26.9
Financing Cash Flow	64.9	180.4	0.00	0.00	0.00

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