Upbeat dinner with management - scope for shares to move higher
On Thursday 17 September Thales' CEO, Patrice Caine, and CFO, Pascal
Bouchiat, hosted a dinner for the sell-side community. We believe the overall
message was positive and there is scope for the shares to move higher both
from potential EPS upside and a potential re-rating.
* Defence market improving; Middle East is key: Thales is clearly more
positive on the outlook for its defence sales compared to 12-18 months ago.
The main driver is the M.East region. Already this year Egypt has signed a
firm contract for Rafale fighter jets (Thales has a c25% share of the Rafale)
and Qatar has selected the Rafale (with the firm deposit from Qatar
expected in the next 1-2 quarters). France hopes the UAE will also buy the
Rafale. DCNS (in which Thales has a 35% stake) hopes to sell surface
warships to Qatar.
* Scope to beat the 9.5% to 10% group EBITA margin target: Thales'
current guidance is to achieve an EBITA margin of 9.5% to 10% by 2017-
18, although we believe it could be at or above the 9.5% level as early as
2016. CFO Bouchiat said that Thales could achieve a group EBITA margin
above 10% (without giving a timeframe) but that it was too early to
formally commit to that.
* Capital allocation – scope for higher dividend payout ratio: Thales is
generating FCF well in excess of its total cash dividend payout and so was
questioned on how it planned to deploy its surplus cash. Thales says that the
current guidance of a 35% dividend payout ratio is a floor. It would prefer to
raise the dividend payout ratio than to buyback shares. CEO Caine
commented that he is not a fan of large M&A transactions which he believes
rarely create shareholder value.
* Transport Division problems "relatively easy to fix": Thales Transport
Division (mostly rail signaling) has performed poorly recently. It is expected
to make a small loss in 2015 and only to be around breakeven in 2016.
However, Thales believes that it can achieve normal transport industry
margins of 7-% "in time". The current problems relate to taking on contracts
in export markets where it proved harder than expected to adapt European
technology to local conditions. Thales' CEO noted that 3-4 years ago its
Avionics division faced technology challenges "ten times more complex"
that in Transport today, but today Avionics is one of Thales' top performing
businesses.
* DCNS outlook harder to predict: Thales does not have management
control of the DCNS naval shipbuilder (as mentioned above, it has only a
35% stake). The business was heavily loss-making in 2014 from
diversification into civil areas (renewable energy, civil nuclear power) and
losses on a nuclear submarine programme. DCNS is on track to do slightly
better than breakeven in 2015 but the roadmap for 2016-18 is rather unclear
to us.