W5 Solutions: Another soft quarter, but outlook is improving

Research Update

2024-07-24

07:45

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Redeye updates on W5 following Q2-results which came in below our expectations. However, while recent quarters have been softer than expected, the outlook is gradually improving and we see potential for better performance in H2 2024 and 2025-26E.

Hjalmar Ahlberg

John Westborg

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Weak Q2 results

W5 reported weaker than expected Q2-results with net sales of SEK98m and EBITDA of -SEK0.2m while we expected SEK126m and SEK21.5m. The soft topline comes on the back of the low order intake seen in recent quarters while the company has continued to invest for future growth resulting in the unexpected negative result.

Increasing order intake

While Q2-results were weaker than expected, the company’s order intake improved sequentially and YoY and there is potential for further increase of the order intake in H2 2024. As such, we expect the balance between order intake and sales to improve which supports our expectations for increased growth in 2025-26E.

Lowered estimates

On the back of the weak Q2-results and lowered expectations for H2 2024, we have cut our 2024E EBITDA from SEK71m to SEK31m. Looking into 2025-26E we also lower our estimates but to a lesser extent with EBITDA being reduced by 8-12%. Our valuation range is also lowered where the new base case stands at SEK85 (SEK93) which implies an EV/EBITDA of 15x 2025E while the share currently trades at c10x 2025E EV/EBITDA.

Key financials

SEKm	2022	2023	2024e	2025e	2026e
Revenues	176.0	387.0	411.7	524.9	629.9
Revenue Growth	23.9%	120%	6.4%	27.5%	20.0%
EBITDA	24.4	56.0	31.4	82.3	104.4
EBIT	17.6	4.8	-18.6	32.3	52.4
EBIT Margin	10.0%	1.2%	-4.5%	6.1%	8.3%
Net Income	13.7	-1.3	-24.2	24.2	39.3
EV/Sales	3.9	3.5	2.0	1.5	1.2
EV/EBITDA	28.1	24.2	26.4	9.8	7.3
EV/EBIT	39.1	283	-44.7	25.0	14.6

Weak Q2-results

W5 Solutions reported net sales of SEK98m and EBITDA of -SEK0.2m while we expected SEK126m and SEK21.5m, respectively. The soft topline comes on the back of the slow order intake seen in late 2023 and early 2024. Worth highlighting is that soft order intake is not related to loss of business but rather delays in potential new orders. Still, this has led to lower sales, and as the company has retained its staff and kept investing in future growth, it resulted in an unexpected negative result in Q2 2024. The Q2 earnings were also impacted by one-off costs of SEK2.5m in the quarter owing to provisions for restructuring costs related to the new business area structure that will be implemented in Q3 2024. On the positive side, the company saw a solid gross margin of 62% while we estimated 58%. The table below summarize Q2-results outcome compared to our forecast.

W5 Solutions results outcome
SEKm	Q2 23	Q3 23	Q4 23	Q1 24	Q2 24E	Q2 24A	Diff, %
Net Sales	112.0	75.8	128.2	95.0	126.4	97.7	-23%
Growth Y/Y (%)	189.5%	200.6%	64.1%	33.7%	12.9%	-12.7%

COGS	-44.1	-30.7	-57.0	-40.7	-53.1	-37.2	-30%
Personnel costs	-28.9	-22.4	-36.7	-34.8	-35.3	-43.0	22%
Other costs	-16.5	-17.3	-25.8	-17.2	-17.5	-19.8	13%

EBITDA	24.7	8.0	11.4	4.5	21.5	-0.2	-101%
EBITDA (%)	22.1%	10.6%	8.9%	4.7%	17.0%	-0.2%

D&A	-16.1	-12.4	-18.7	-12.5	-12.5	-12.5	0%

EBIT	8.6	-4.4	-7.3	-8.0	9.0	-12.8	n.m.
EBIT %	7.7%	-5.8%	-5.7%	-8.4%	7.1%	-13.1%

Net income	5.9	-4.8	-7.9	-11.8	6.0	-10.6	n.m.

EPS, SEK	0.44	-0.35	-0.53	-0.78	0.40	-0.70	n.m.

Source: Redeye Research

Increasing order intake

While Q2-results were weaker than expected, the company saw a decent order intake of SEK115m during the quarter, which can be compared to SEK75m in Q1 2024 and SEK86m in Q2 2023. The improved order intake was among other driven by three live fire product orders received in April, including a first order relating to a 7-year framework agreement with Latvian Armed Forces. Looking into Q3 2024, the recently awarded framework agreement worth SEK500m over five years with an expected order of SEK100m in August should result in further improvement of the order intake. In July, the company also announced a new subcontracting framework with Thales for Li-Ion batteries spanning over 15 years, and series production is expected to begin in 2025. Finally, W5 commented that it remains optimistic looking forward, and sees strong prospects for sustainable growth in line with its financial targets. Overall, the outlook supports expectations of an improved balance between order intake and revenue in the coming quarters, as illustrated in the chart below.

W5 order book and order intake R12m

Source: Redeye Research

Lowered estimates

On the back of the weak Q2-results and lowered expectations for H2 2024, we have cut our 2024E EBITDA from SEK71m to SEK31m. Looking into 2025-26E, we also lowered our estimates but to a lesser extent, with EBITDA being reduced by 8-12%. As 2024 is becoming a transition year with slower-than-normal growth, we expect growth in 2025E to see stronger than average growth. We also expect the company to see solid operating leverage, as we forecast a limited opex increase. The table below summarize W5 Solutions key financials for 2022-26E.

W5 Solutions: Group financials 2022-26E
SEKm	2022	2023	Q1 24	Q2 24	Q3 24E	Q4 24E	2024E	2025E	2026E
Net Sales	176	387	95	98	91	128	412	525	630
Growth Y/Y (%)	24%	120%	34%	-13%	20%	0%	6%	28%	20%

COGS	-81	-161	-41	-37	-36	-51	-165	-210	-252
Gross profit	95	226	54	61	54	77	246	315	378
Gross margin, %	54%	58%	57%	62%	60%	60%	60%	60%	60%

Personnel costs	-51	-107	-35	-43	-38	-40	-157	-168	-197
Other costs	-23	-71	-17	-20	-13	-18	-67	-68	-80

EBITDA adj	24	56	4	2	5	20	31	82	104
EBITDA adj (%)	14%	14%	5%	2%	5%	16%	8%	16%	17%

Non-recurring	0	0	0	-3	0	0	-3	0	0

EBITDA	24	56	4	0	5	20	29	82	104
EBITDA (%)	14%	14%	5%	0%	5%	16%	7%	16%	17%

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	-3	2	17	19	72	92
EBITA (%)	11%	12%	2%	-3%	2%	14%	5%	14%	15%

EBIT	18	5	-8	-13	-8	7	-21	32	52
EBIT (%)	10%	1%	-8%	-13%	-9%	6%	-5%	6%	8%

Net income	14	-1	-12	-11	-7	5	-24	24	39

EPS reported, SEK	1.1	-0.1	-0.8	-0.7	-0.4	0.3	-1.6	1.6	2.6
EPS ex. amortization	1.2	2.1	-0.3	-0.2	0.1	0.8	0.4	3.6	4.6

Source: Redeye Research

Valuation

We have adjusted our valuation range following lowered estimates and our new base case stands at SEK85 (SEK93) while the new bull case is SEK150 (SEK170) and the bear case is SEK45 (SEK50). The share currently trades at c10x 2025E EBITDA while our base case implies c15x 2025E 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	45	85	150
OW M&A upside	9	15	25

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

EBITDA-margin 2025-2039	14%	16%	18%
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 SEK85 in our base case, which implies a multiple of 15x EBITDA 2025E and 12x EBITDA 2026E. 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 SEK16 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	411.7	524.9	629.9
Cost of Revenue	81.3	161.4	165.4	210.0	252.0
Operating Expenses	70.3	169.6	214.8	232.7	273.5
EBITDA	24.4	56.0	31.4	82.3	104.4
Depreciation	4.5	8.0	9.9	10.0	12.0
Amortizations	2.4	43.2	40.1	40.0	40.0
EBIT	17.6	4.8	-18.6	32.3	52.4
Shares in Associates	0.00	0.00	0.00	0.00	0.00
Interest Expenses	0.59	2.2	6.3	0.00	0.00
Net Financial Items	-0.61	-1.4	-5.9	0.00	0.00
EBT	16.9	3.3	-27.0	32.3	52.4
Income Tax Expenses	3.2	4.6	-2.8	8.1	13.1
Net Income	13.7	-1.3	-24.2	24.2	39.3
Balance sheet
Assets
Non-current assets
SEKm	2022	2023	2024e	2025e	2026e
Property, Plant and Equipment (Net)	7.6	13.4	10.6	11.6	12.8
Goodwill	20.1	228.2	204.1	180.1	156.1
Intangible Assets	8.1	107.0	94.9	89.4	86.0
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	310.5	282.0	255.8
Current assets
SEKm	2022	2023	2024e	2025e	2026e
Inventories	43.6	83.8	82.3	105.0	126.0
Accounts Receivable	96.7	78.9	82.3	105.0	126.0
Other Current Assets	13.8	34.9	20.6	26.2	31.5
Cash Equivalents	48.0	35.2	48.9	73.3	112.5
Total Current Assets	202.2	232.9	234.1	309.5	396.0
Total Assets	238.5	582.4	544.6	591.4	651.8
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	280.8	305.0	344.3
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	41.2	52.5	63.0
Other Current Liabilities	62.4	120.3	89.0	100.4	110.9
Total Current Liabilities	84.6	163.1	149.5	172.1	193.1
Total Liabilities and Equity	238.5	582.4	544.6	591.4	651.8
Cash flow
SEKm	2022	2023	2024e	2025e	2026e
Operating Cash Flow	-40.9	89.4	24.7	45.9	65.1
Investing Cash Flow	-29.4	-282.6	-11.0	-21.5	-25.8
Financing Cash Flow	64.9	180.4	0.00	0.00	0.00

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