This Defense Company Has a Little Bit of Palantir Inside. Its Stock Is a Buy.
Paris-based Thales looks like a plain-vanilla defense stock and trades like one. Its artificial-intelligence component sets it apart.
What happens if you take the best parts of Lockheed Martin and combine them with artificial-intelligence darling Palantir Technologies? You get French defense company Thales—and its stock looks like a winner.
Paris-based Thales (pronounced TAL-us) is far from a household name. The company has three divisions—Defense and Security, Digital Identity and Security, and Aerospace. Of the three, the defense unit, which makes computer systems for airplanes and radar, sonar systems for submarines, and helps John F. Kennedy International Airport in New York defend itself against cyberattacks, produces the most sales—some 2.3 billion euros ($2.5 billion) in the first quarter, or 52% of Thales’ revenue. It also produces the fastest growth—its sales rose 13.1% over the past 12 months, and orders climbed 128%. In March, Thales said it was aiming for organic sales to increase between 4% and 6% this year and for its margins to increase to as high as 12%, guidance it reiterated this past week.
Since Thales looks like a plain-vanilla defense stock, it trades like one, too. At 17.8 times 12-month forward earnings, its multiple isn’t all that different from Lockheed Martin, which fetches 17.5 times; RTX, which goes for 18.2 times; or BAE Systems, which trades for 19.2 times. Thales’ AI services business, which it is embedding in products across the company, makes it anything but a run-of-the-mill defense contractor. Artificial intelligence is already helping to boost sales across the company. In the fourth quarter, it booked 13 large orders, including a €2 billion contract with the U.K. Ministry of Defence to help the Royal Navy incorporate AI into its maritime operations. It also signed a deal with the United Arab Emirates for pilot training on French Rafale jet fighters.
Ultimately, the realization that AI can boost growth across the company should justify a higher valuation.
“Thales is at the forefront of Cyber and Artificial Intelligence,” writes Deutsche Bank analyst Christophe Menard. “When synergies with the rest of the group become fully apparent, the stock could continue rerating, with tech peers as potential benchmarks.”
The most obvious comparison is American tech darling Palantir, which makes AI software for analyzing massive amounts of data and boasts the U.S. government as its biggest customer. Its products can manage deployments and streamline decision-making, among other functions. Caught up in the AI boom, Palantir has gained 195% over the past year and trades at 65.8 times 12-month forward earnings.
No one should expect Thales, which has gained 14% over the past 12 months, to earn a Palantir-like multiple or even produce the same type of gains. Hardware is more capital-intensive than software, and Thales is neither an AI nor defense pure play. Its smart card business was a drag on the digital identity unit, while its satellite business was coping with project delays and weakening demand. The company, though, said in March that it can improve margins in those areas, while allowing the other businesses to shine.
“With the risk to space and smart card estimates now largely relegated to history and 2024 guidance broadly consistent with expectations, we are now more comfortable with the risks/reward trade-offs,” Barclays analyst Milene Kerner wrote in March, though she wasn’t comfortable enough to change her Equal Weight rating and €150 price target on the stock—5% lower than its current price around €158.
Deutsche Bank’s Menard, though, sees more upside. He has a €180 price target on the stock, 14% higher than currently, based on a combination of discounted-cash-flow, sum-of-the-parts, and free-cash-flow methodologies. Based on free cash flow alone, the stock would be worth €190, up 20%.
Those valuations are primarily driven by the view that Thales is a defense company, and until recently it hadn’t been presenting itself an AI company. That has started to change. At its March 28 Media Day, Thales announced the creation of a research group called cortAIx that will highlight its artificial-intelligence capabilities. It’s so confident of those abilities that when asked on its April 30 conference call about making an acquisition to boost its AI efforts, Chief Financial Officer Pascal Bouchiat responded in the negative.
“We have no interest on M&A on AI, and the reason is quite simple,” he explained. “I mean, we’ve got everything we need from the inside, from Thales’ standpoint.”
For now, the stock is still flying under the radar. It might not be for long.