Description

Summary

We like the value proposition of Indra Sistemas S.A. ("Indra"), a leading global technology and consulting company headquartered in Spain. Indra is well-positioned to benefit from increasing defense spending in Europe, growth in digital transformation services, and its strong presence in attractive end markets. 

The company’s strategic shift towards the higher-margin Defense business, coupled with potential margin improvements in its legacy IT segment is a key driver of the investment thesis. This shift is expected to lead to significant EBITDA and EBIT margin expansion, contributing to increased profitability and, consequently, higher shareholder value.The current valuation is undemanding and reflects the economics of the less performing legacy segments rather than the shift towards future higher margin businesses. 

Key investment highlights include:

·       Strong revenue growth, with 13% CAGR 2021-2023 

·       Expanding profitability, with EBIT margin improving to 8.0% in 2023

·       Robust order intake of €4.58 billion and record backlog of €6.78 billion

·       Market leader in defense & security, air traffic management, and digital services

·       Attractive valuation at 5.5x 2025E EV/EBITDA, discount to peers

We believe the shares are worth €28.00 target price, representing 65% upside from current levels. Indra offers an attractive combination of growth, improving profitability, and reasonable valuation.

Introduction to the Business

 Indra Sistemas S.A. is a leading global technology and consulting company headquartered in Madrid, Spain. The company provides proprietary solutions and digital services to clients across multiple industries, with a focus on high-value and mission-critical applications. Indra operates through four main business segments:

·      Defence & Security

·      Air Traffic Management 

·      Mobility

·      Minsait (Information Technology)

Key Facts:

- Founded: 1993

- Listed: Madrid Stock Exchange (IDR), part of IBEX 35 index

- Employees: 57,755 (as of Dec 2023)

- Global presence: Operations in over 150 countries

- 2023 Revenue: €4,343 million

- 2023 EBIT: €347 million

- Market Cap: €3,012 million (as of Aug 2024)

Revenue Breakdown by Segment (2023):

Revenue Breakdown by Geography (2023):

Financial Performance (2021-2023):

Indra has demonstrated strong growth and improving profitability over the past three years, with revenue growing at a 13.2% CAGR and EBIT at a 20.3% CAGR from 2021 to 2023. The company has also expanded its margins, with EBIT margin increasing from 7.1% in 2021 to 8.0% in 2023.

Business Segments Overview

Minsait (64.4% of 2023 revenue):

Minsait is Indra's digital transformation consulting and information technology services arm. It offers solutions in areas such as digital customer experience, cybersecurity, big data and analytics, and cloud services. The segment grew 10.1% in 2023 to €2,798 million in revenue, with an EBIT margin of 5.4%. It offers a comprehensive suite of solutions and services designed to help clients navigate the complexities of the digital age. Key offerings include:

·      Cloud Computing: They provide cloud services, offering clients flexible and scalable IT infrastructure to support their digital initiatives.

·      Cybersecurity: Minsait helps clients safeguard their digital assets and sensitive information from cyber threats through advanced security solutions.

·      Data Analytics: They empower clients to extract valuable insights from their data, enabling them to make informed business decisions and identify new opportunities.

·      Industry-Specific Solutions: Minsait also offers tailored solutions for various sectors, including energy, healthcare, financial services, public administration, and telecommunications.

Key Focus Areas of Minsait:

• Payments: Minsait is developing end-to-end proprietary software for payment processors, end clients, and fintech companies, delivered in an as-a-Service model.

• Sustainability: They are creating digital assets and use cases focused on energy transition, environmental protection, circular economy, and financial inclusion, aligning with the growing global focus on sustainability.

• Other High-Potential Technologies: Minsait is also exploring new relationship models using AR/VR, automating physical operations with IoT and IT-OT integration, and leveraging blockchain technology.

Defence & Security (18.8% of 2023 revenue):

Indra is a leading player in the European defence industry, providing advanced solutions for air defense, electronic defense, border surveillance, and cybersecurity. The segment has shown strong growth, with revenue increasing 23.4% year-over-year in 2023 to €817 million. EBIT margin for the segment was 17.8% in 2023, the highest among all segments.

 Source: Company Investor Presentation July 24. 

Air Traffic Management (8.3% of 2023 revenue):

Indra is one of the main global suppliers of air traffic management systems, offering solutions for en-route navigation, approach and landing systems, and airport management. The segment grew 20.8% in 2023 to €361 million in revenue, with an EBIT margin of 12.3%.

Mobility (8.4% of 2023 revenue):

This segment focuses on intelligent transportation systems, including solutions for urban traffic management, toll systems, and ticketing systems for public transport. Revenue grew 5.3% in 2023 to €366 million, with an EBIT margin of 1.6%.

Drivers of Future Growth and Profitability

Indra's strategic plan, "Leading the Future," outlines several key initiatives to drive future growth and profitability:

* Management targets

Digitalization and Technological Transformation:

The accelerating pace of digital transformation across industries provides substantial growth opportunities for Indra's Minsait segment. As businesses and governments increasingly adopt technologies such as AI, cloud computing, and cybersecurity solutions, Indra's expertise in these areas positions it to capture a growing share of this market.

Sustainable Transportation and Smart Mobility:

Increasing urbanization and the focus on sustainable transportation solutions are driving demand for Indra's Mobility segment offerings. The company's intelligent transportation systems and ticketing solutions are well-aligned with the global trend towards smart cities and environmentally friendly urban mobility.

Air Traffic Recovery and Modernization:

As global air traffic continues to recover from the COVID-19 pandemic, there is an increasing need for modernization of air traffic management systems. Indra's strong position in this market, combined with its innovative solutions, positions it to benefit from this trend.

Focus on High-Value Solutions:

Indra's strategy involves concentrating on high-value, mission-critical solutions that offer higher margins and more stable, long-term relationships with clients. This focus is expected to drive profitability improvements across all segments.

International Expansion:

While Spain remains Indra's largest market, the company is actively pursuing growth in international markets. The Americas and Europe (excluding Spain) already account for over 40% of revenue, and further expansion in these regions, as well as in Asia, Middle East, and Africa, presents significant growth opportunities.

Strong Order Intake and Backlog:

Indra's order intake remains robust, with €4,583 million in new orders in 2023. The company's order backlog stood at €6,776 million at the end of 2023, representing 1.56 times its last twelve months' sales. This provides good visibility on future revenue growth.

Strategic Acquisitions:

Indra has a track record of making strategic acquisitions to enhance its capabilities and market position. Recent acquisitions, such as Park Air Systems Ltd in the UK and Deuser Tech Group in Spain, have strengthened its position in key markets and technologies.

Indra Space:

The creation of Indra Space represents a strategic move by Indra to capitalize on the burgeoning space industry. It highlight the increasing recognition of space as the 'fifth domain' in defense, crucial for the EU's strategic autonomy. Indra aims to position this NewCo as a major player in the European space ecosystem, specifically targeting Tier-1 status, which implies having comprehensive, end-to-end capabilities in the space sector.

Indra Space will not be a spin-off but rather a new company, initially focusing on the ground segment of the space value chain. This includes vital infrastructure like ground stations and the software to control satellite missions and applications. However, the long-term vision is for Indra Space to expand its capabilities across the entire satellite value chain, from manufacturing to downstream services. This expansion will be achieved through strategic acquisitions and partnerships, aiming to generate over €1 billion in revenue by 2030. The decision to create a separate entity for space activities underscores Indra's recognition of the sector's growth potential and its strategic importance in both defense and civil applications. By establishing Indra Space, Indra aims to solidify its position as a leader in the European space industry and capture a significant share of the market's projected growth.

These strategic initiatives are expected to drive significant growth in Indra's revenue and profitability in the coming years. The company's management has set ambitious targets, aiming to reach €6 billion in revenue and an EBITDA margin of over 12% by 2026.

Investment Thesis

The investment thesis for Indra is mostly driven by the strategic shift towards higher-margin businesses,particularly the Defense segment.  Minsait, while the largest segment currently, operates at a lower EBIT margin compared to Defense. The strategic plan aims to increase Minsait's autonomy, potentially through partnerships, which could improve its margins over time. However, the more immediate and significant margin expansion is expected to come from the growth of the Defense business.

Source: Company Investor presentation, July 2024.

Beneficiary of Increasing European Defense Spending

Indra is well-positioned to benefit from the secular trend of increasing defense spending in Europe. Following Russia's invasion of Ukraine, most European countries have announced intentions to increase defense budgets, with a medium-term goal of reaching the 2% of GDP threshold required by NATO.

Specifically, Spain has committed to converging to 2% of GDP defense spending by 2029, up from 1.2% currently. This represents a significant growth opportunity for Indra's Defense & Security segment, which accounted for 19% of 2023 revenues.

There is a projected CAGR of +4-5% in global defense spending from 2023 to 2030, with even higher growth rates for NATO Europe (+7-8%) and Spain (+11-12%). The total procurement spending in this period is estimated to be between €850-950 billion. The tech spending is also projected to grow at a healthy rate of +6-7% CAGR. These trends suggest a robust market for Indra's defense and technology solutions.

Indra's Defense & Security segment delivered strong 23% year-over-year revenue growth in 2023, with an impressive 18.6% operating margin. The segment's order backlog stands at €2.95 billion, providing good visibility into future growth.

Digital Transformation Driving Minsait Growth

Indra's Minsait segment, which provides IT services and digital transformation consulting, is benefiting from the broad trend of companies investing in digitalization. Minsait delivered 10% year-over-year revenue growth in 2023, with improving profitability. The segment's order intake grew 16.5% in 2023 to €3.05 billion, with backlog up 25% to €2.17 billion. This provides a strong foundation for continued growth in 2024 and beyond.

Minsait has particular strength in financial services, energy & utilities, telecom & media, and public administration verticals. The company's expertise in emerging technologies like AI, cloud, and cybersecurity positions it well to capture growing digital transformation spending. The July 2024 investor presentation shows that Minsait's sales in the first half of 2024 were driven by growth across all geographies, with a particular emphasis on America and Europe. Additionally, the joint sales of Digital and Solutions grew by 13% in 1H24 and accounted for 50% of Minsait's sales, indicating a successful shift towards higher-margin digital offerings.

Market Leadership in Air Traffic Management

Indra is a global leader in air traffic management systems, with a strong position in both civil and defense markets. The Air Traffic segment delivered impressive 21% year-over-year revenue growth in 2023, with 12.3% EBIT margin.

The company aims to solidify its European leadership and expand into high-growth regions like North America and Asia-Pacific. The strategic plan emphasizes capturing large system renewal opportunities and forming technology partnerships in these regions. The entry of NAV Canada into the iTEC alliance further strengthens Indra's position in the North American market. The investor day presentation highlights significant growth opportunities in the ATM segment, with identified opportunities representing ~80% of the projected 2026 organic revenue. The focus on capturing surveillance system renewal programs and developing unmanned traffic management (UTM) solutions further adds to the growth potential.

Improving Profitability and Cash Flow Generation

Indra has demonstrated consistent margin expansion over the past several years. EBIT margin improved from 7.8% in 2022 to 8.0% in 2023. Management is targeting further margin expansion, driven by operating leverage, improved business mix, and cost efficiencies.

The company generated strong free cash flow of €312 million in 2023, up 24% year-over-year. This has allowed Indra to reduce net debt to just €107 million, or 0.24x EBITDA. The strong balance sheet provides flexibility for organic investments and potential M&A.

Management: 

Management ownsership remains very small. As per the annual report, the management (directors) of Indra collectively owned 113,521 shares, representing 0.064% of the total share capital. The 2023 annual report mentions that the top management's mid-term incentive scheme (IMP) will be linked to the guidance targets, suggesting that management has a direct financial incentive to achieve the goals they have set. 

Shareholders:

The Spanish state holds a 28% stake in the business through the S.E.P.I. The state has committed to higher NATO spending and want to make Indra into a national and European defense champion to capture as much of the increased spending as possible at a local level. This should be seen as supportive of the investment thesis. 

Source: Company Investor Presentation July 24. 

Valuation

To value Indra, we use a combination of discounted cash flow (DCF) analysis and peer comparison.

DCF Valuation:

Assumptions:

- Revenue CAGR of 10% for 2024-2028 (slightly below historical growth rate)

- EBIT margin expanding to 9.5% by 2028

- Effective tax rate of 25%

- WACC of 10%

- Terminal growth rate of 2%

Based on these assumptions, our DCF model yields a fair value of €29 per share.

Peer Comparison:

We compare Indra to a group of European and global technology consulting and IT services companies:

 Indra is currently trading at a significant discount to its “peers”, despite its strong growth profile and improving margins. Applying a target EV/EBITDA multiple of 8.0x (still below peer average) to our 2024 EBITDA estimate of 575m€ yields a fair value of €26 per share.

Blending our DCF valuation and peer-based valuation (40% weight), we arrive at a target price of €28.00 per share, representing 65% upside from the current price of €17.00.

Investment Risks and Mitigation:

While the company's significant exposure to government contracts, particularly in Defence & Security, could be impacted by shifts in political priorities or budget constraints, Indra's diversified portfolio across multiple segments and geographies helps mitigate this risk. The potential economic cyclicality affecting its Minsait segment during downturns is counterbalanced by the more stable, long-term nature of its defence and air traffic management contracts. 

The highly competitive technology services market presents challenges, but Indra's strong market position, particularly in niche areas like air traffic management and defence systems, provides some insulation against competitive pressures. Lastly, while large-scale, complex projects inherently carry execution risks, Indra's long track record of successful project delivery and robust project management practices help mitigate potential cost overruns or delays

Catalyst

Strategic shift towards higher margin defense business, with increased defense sending in Europe as tailwind.