Its been a while since I posted on ADA and HC in general. Was away on holidays when they came out with their big upgrade. I refrained from posting in the hopes of picking some more up in any pullback after the big run to $1+
The thesis I provided months ago is playing out. I won’t go over the details of my thesis because it is all there in prior posts. Instead I will focus on why the earnings guidance they have provided is VERY conservative and why ADA still remains very cheap.
They gave guidance of “at least 25% growth” on FY15’s PBT of $5.9m. That translates to guidance of at least $7.5m PBT in FY16.
Consider the following:
- In FY15 there was a $700k bad debt expense, so underlying PBT is $6.6m already. All the drivers of the strong result in FY15 will continue into FY16 and beyond (they are the contracts with FAA, USAF, US Army, ATOP)
- In April ADA acquired the assets of the CSC business. It was well known in the market that CSC wanted to exit simulation. ADA got a very good deal and assumed no staff with all of the CSC sites to be serviced by ADA staff. This results in very high margins. The contribution to PBT in the next year will, on my numbers, be $1-$2m on its own. They are completely dominant in the US Simulation market with significant competitive advantages in their technology (voice rec and ongoing database), existing installed base and customer service/support capability).
- The FAA are likely to upgrade their existing systems (around 50) as shown by the FAA’s Capital Investment Program allocating US$3m (AUD$4m+) to upgrades of their TSS program for this year. Upgrade revenue is very high margin and is additional to the support contracts already announced to market ($46m for FAA, $25m for USAF). If the FAA upgraded their simulation systems in FY16 that would be AUD$2m+ in PBT.
- Watch for more sales of simulators to the FAA. There is a lot of evidence out there that it is coming. Will share this in time.
- Global upgrades of ATM will continue. ADA highlighted some of these opportunities in their result. Some posters on here keep coming back to the cyclicality issue but they are not factoring in the stickiness of the deals that will likely be won by ADA in the years to come. $120 billion will be spent on upgrading ATM worldwide out to 2021 (ICAO figures) and any deals won, either in simulation or ATM, come with significant attached maintenance and support revenue. That $120b in spending is intentionally staged out in blocks, it won’t come in a rush or stop in 2021, but will continue beyond 2021 well into 2028 where the upgrade schedule ceases (read ICAO block phase program for more detail).
What we have is $6m+ of PBT largely locked in from existing contracts to continue in FY16 and $1-$2m PBT from CSC contribution. There is no allowance of additional contract wins in the FY16 guidance figures, which allows them to provide the “at least 25% growth” guidance some 12 months away from the end of the year, i.e. it is a very conservative figure.
I expect $8m+ PBT in FY16, with the higher end of my numbers significantly above that They have enough accumulated tax losses to pay no tax in FY16, so that is free cash flow. The market cap is still only $80m.
What the market is missing is how significantly the model has changed since 2011. All customers are locked in to large support contracts, recurring revenue is now well above 50% and they are constantly upgrading the systems to provide the latest databases, technologies, equipment, etc.
Opportunities for growth will continue at least for the next five years and if they win their share the company will be much larger than it is today. They have market leading positions in a market that is undergoing levels of investment not seen for 30 years when the current ATM systems were largely developed.
Sustainable profit growth, high recurring revenue, market leading positions (by a significant margin in their main business - simulation), key competitive advantages, high returns on capital and a huge uplift in spending in the markets in which they operate.
It warrants at least a market multiple and likely a premium as they remain in the early phases of growth.
This business is now worth at least $1.50 (i.e $120m market cap would be 15x FY16 FCF, less on an EV basis, in FY16 and a 5% yield on the lower end of my numbers). If they hit the higher end of my numbers (watch out for any additional sales to FAA or US Army and progress with significant ATM programs in Europe and APAC) then $2+ would be quite achievable (still only ~15x FY16 FCF).
The catalysts to the re-rate from here will be 1) when the market realises how strong growth in FY16 is likely to be and 2) that it realises it is not a one-off result.
Take a look at the likes of SEN, NTC and ALU to see the types of multiples these types of businesses with strong tailwinds are trading on. The market is yet to latch on to the opportunity that ADA has in front of it.
I bought more shares in the recent pullback and have a larger position than when I first wrote about it.
(20min delay)
