In September 2023 I will have the coverage for Elbit Systems Ltd. (NASDAQ:ESLT) with a Hold rating as I believed there was no compelling investment case as the shares had risen significantly due to increased demand driven by the war in Europe. Little did I know that Israel, home to Elbit System, would be in armed conflict less than a month later. In this report, I will discuss the most recent gains and update my price target and rating.

Elbit Systems: Revenue and profit grow on flat margins

Second quarter revenues rose 11.85% to $1.63 billion. Aerospace revenues fell 1.2% to $481.2 million. C4I and Cyber ​​revenues rose 11.3% to $187.7 million, driven by sales of radio systems. ISTAR & EW, which focuses on Intelligence, Surveillance, Target Acquisition and Reconnaissance & Electronic Warfare, saw revenues rise 8.9% to $318.8 million, while Land System revenues rose nearly 37% to $402.7 million, driven by sales of munitions. Elbit Systems of America saw revenues increase 10.6% to $392.9 million. So we saw growth in all segments except aerospace. When we look at revenues and the possibility of a Middle East ceasefire in mind, we also have to look at how much revenue came from Israel. In the second quarter, 27.3% or $444 million of sales were to Israel, up from $244.5 million and 16.8% the year before. Excluding sales to Israel, revenues were down 2.2% year-over-year. It is not necessarily the case that without a conflict in the Middle East there would be a decline in sales, as some of the sales flow to Israel could be a prioritization of sales at the expense of other geographic regions, but it is clear that the Middle East conflict is the primary driver of growth.

Adjusted operating profit rose 13% to $130.5 million for a 10 bps expansion in margins to 8%. Uncompensated labor costs related to Swords of Iron War were $3.3 million, up from $2.4 million in the prior quarter.

Backlog grew from $10 billion in 2019 to $21.1 billion by the end of Q2. Between 2020 and 2024, backlog had a compound annual growth rate of 20% and 9% on revenue.

What are the risks for Elbit Systems?

The risks for Elbit Systems are a cooling of demand in the short term from Israel, which could be the case if there is some form of de-escalation in the region. Likewise, if the conflict escalates further, it could stimulate demand for Elbit System products and services to some extent. Furthermore, we monitor uncompensated labor costs. When reserve forces are mobilized, the Israeli government covers part of the labor costs. However, in some cases there is a surplus of labor costs that exceeds the compensation limit and companies record this as uncompensated labor costs.

Is Elbit Systems a good stock to buy?

To determine multi-year price targets, the Aerospace Forum has developed a stock screener that uses a combination of analyst estimates of EBITDA, CapEx and FCF, along with the most recent balance sheet data, cash flow statements and my assumptions about debt service, share buybacks and dividends. Each quarter, we review those assumptions and update them accordingly.

For Elbit, we see that analysts now expect EBITDA to grow by 7% between 2024 and 2026, and the same growth rates are observed for free cash flow. This has led to a switch in the hold rating from hold to buy with a price target of $236, representing an upside of 19%.

Conclusion: Elbit Systems shares are a bargain now, but we’ll keep an eye on the Middle East conflict

Although Elbit Systems derives a significant portion of its revenue streams from outside Israel, the numbers show that current growth is unsurprisingly driven by increased demand for defense equipment and services from Israel. While I have a Buy recommendation on the stock, I must point out that any easing of the conflict in the Middle East could reduce Elbit’s growth. Currently, the threat level is still high and while there is talk of ceasefires, it seems to me that demand for defense solutions will remain high.