As Coronavirus Cools Defense Spending, Israeli Firm Elbit Underperforms Nasdaq

Yoram Gabison
Yoram Gabison
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Grounded Boeing 737 MAX aircraft are seen parked in an aerial photo at Boeing Field in Seattle, Washington, U.S., July 1, 2019.
Grounded Boeing 737 MAX aircraft are seen parked in an aerial photo at Boeing Field in Seattle, Washington, U.S., July 1, 2019.Credit: Lindsey Wasson / Reuters
Yoram Gabison
Yoram Gabison

The massive amounts of money that governments around the world have handed out to offset the loss of economic activity resulting from the coronavirus pandemic has cooled investors’ interest in defense companies.

Elbit Systems has performed relatively well against the S&P Aerospace and Defense Select Industry Index and the MSCI World Aerospace and Defense Index, its share price down only 25% compared to the indexes’ loss of 29% from the beginning of the year, but the share has underperformed the Nasdaq Stock Market by 40% this year. From October 2015 to the end of 2019, Elbit Systems outperformed Nasdaq by 16%.

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Investors’ concerns are not baseless, as was seen Monday, when Elbit announced that it expected to record a noncash write-off for the third quarter of about $60 million due to a loss in asset value and inventory write-offs. It will not affect the company’s per-share non-GAAP earnings, by virtue of being a one-time write-off. The bulk of the write-off is due to the loss in asset value at subsidiary Universal Avionics, which develops avionics systems for civil aviation. Apparently the write-off announcement didn’t entirely surprise the market, as the company’s share price plunged in the final 30 minutes of trade Sunday.

The write-off stems from a drop in demand for commercial aviation goods and services due to the slowdown in commercial air traffic and the expectation that it will take several years for that market to return to 2019 levels.

Additionally, manufacturers of commercial airplanes have announced plans to reduce production to adapt to the low demand. Passenger flight hours were down 75% for August 2020, compared to the previous August. The figure was down 79% for July, so August’s figures are actually a slight improvement.

Elbit’s commercial aviation business operations bring in hundreds of millions of dollars a year. The company’s main commercial operations are run by the Tucson, Arizona-based Universal Avionics, which it bought in 2018 for $120 million. It also has a division in Haifa that develops screens and other advanced equipment for commercial helicopters. Another subsidiary, the Carmiel-based Cyclone, also builds commercial flight components.

Universal Avionics has a factory in Texas with 400-500 employees. It develops synthetic vision systems, a computer-mediated reality system that uses 3D to assist pilots in understanding the airplane’s surroundings when visibility is low or nonexistent, and a terrain awareness system, which warns pilots of obstacles in the flight path. Its products are for executive aircraft, cargo planes and helicopters.

Elbit acquired the Universal Avionics so that it could implement in the civilian sphere products that it developed for military use, particularly programs meant to compensate for poor visibility, given that some 20% of U.S. flights experience delays or cancellations due to weather.

While the current write-off is entirely attributed to the pandemic’s impact on civilian flights, market sources believe the pandemic’s influence on Elbit will go beyond that. Liran Lublin, head of research at the ABA Investment House, says that shrinking defense budgets and integrating operations with Israel Military Industries, now known as IMI Systems, will weigh on Elbit’s results. He set a target price of $120, just 4.6% above Elbit’s share price at the start of trade on Wall Street Monday, explaining that he expects the company’s growth to slow over the next two years, but adding that he thinks it is likely to preserve its current level of profits and cash flow.

Another factor weighing on Elbit at the moment is the strong shekel. Some 80% of Elbit’s production is in Israel, and 40% of its salary costs and 65% of its operating expenses are in shekels. While the company has mostly hedged its dollar exposure for 2020, it has not yet done so for 2021, he noted. The company is suffering from smaller profit margins and weak cash flow, and until these two measures improve, the market will continue with its lack of faith in the company’s stock, he said.

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