Don’t Let RADA Electronic Industries’ Double-Digit Rate Of Sales Growth Fly Under Your Radar (NASDAQ:RADA)

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RADA Electronic Industries, Ltd. (NASDAQ:RADA) is an underrated company that has the potential for explosive growth. With an attractive valuation and a projected double-digit percentage rate of annual sales growth for the foreseeable future, RADA is an excellent growth stock at a reasonable price.

Company overview

RADA is an Israeli-based defense contractor specializing in the development of military avionics systems and inertial navigation systems for manned and unmanned aircraft and tactical radars for defense and border protection applications. Although sporting a mere $305M market cap and workforce of 167 employees, RADA has an extensive history dating back to 1970. The company enjoyed seemingly better days before the turn of the century. The performance of its stock has been trending down until 2016, until its Radars business started taking off. The Radars business has now grown into RADA’s biggest revenue stream, projected to bring a double-digit rate of growth for years to come.

Data by YCharts

Business Segments

Avionics

RADA’s legacy business is its Avionics segment. For over 30 years, the company has been manufacturing various avionics systems such as video/data recorders, ground debriefing systems, and inertial navigation systems. Over the last 5 years, this segment accounted for around $10M of revenue annually. RADA describes it as its “stable, cash generating” business.

Radars

RADA’s state-of-the-art AESA Gallium Nitride (GaN) radar technology provides its customers with protection for troops, vehicles, infrastructure, and borders. Its radars are sleek and compact allowing customers to easily attach them to the side of an armored vehicle or on a tripod. RADA manufactures various radars capable of detecting UAVs, Fighter Jets, Mortars, Missiles, Pedestrians, Ground Vehicles, Vessels, and other targets at various distances. The superiority of RADA’s radars stems from the cutting-edge software that allows each radar to simultaneously serve various functions, making it the perfect multi-mission solution. This allows RADA’s customers to extract the greatest value from each unit.

While having a “cash cow” is beneficial to the company, its Radars segment is the driving force behind RADA’s massive growth. With Avionics consistently generating around $10M, the Radars business grew from $1.5M to over $35M in annual sales in the last five years, bringing it to over 75% of RADA’s total revenue. The growth isn’t stopping there. RADA expects around $60M in Radar revenues for 2020, implying a growth rate of around 70% from last year. With a total addressable market growing to over $5B over the next decade and RADA being a major player in the space, it isn’t a stretch to say that RADA’s growth will continue.

Source: RADA Electronic Industries

Competition

RADA’s Radar business has several competitors such as SRC, Elta, and a few other players seemingly outside RADA’s niche. SRC typically makes larger radars and its compact vehicle-attached radars, compared to RADA’s, seem much less compact.

Elta, a subsidiary of Israeli Aerospace Industries (IAI), makes compact tactical radars, however they make up a small portion of its product lineup. Interestingly, IAI is RADA’s largest customer, making up 12% of RADA’s revenues. Although it is unclear how much of the business is attributed to radar sales (versus avionics). While I have yet to find clarification on this point, if IAI uses RADA for radars rather than Elta, this may suggest that IAI concedes that RADA’s radars are either superior or a better value for some applications. (There is also the chance that buying from a third-party allows IAI to markup profit whereas it may not be able to do so for goods transferred internally. However, I am unsure if that wrinkle exists in Israeli government procurement law as it does in the US.)

Source: RADA Electronic Industries

Unlike Elta and SRC, RADA specializes in compact tactical radars. Also, RADA’s competitors are much larger organizations that have extensive product offerings. RADA is truly the only pure-play on compact tactical radars. The specialization in the radars business means that R&D expenses will fuel the high growth more directly. In 2019, R&D expenses as a percentage of sales was 17%. With a Debt Ratio of 32%, a Current Ratio of 3.2, and a cash balance of $30M, RADA is well-positioned to continue growing its R&D, helping it maintain its competitive edge.

Future revenue potential

RADA’s growth potential is what makes this company such an attractive investment. In the Q2 earnings release, RADA increased its revenue projections from $65M to $70M for 2020. Even in the environment of the coronavirus pandemic, RADA’s customers are showing great interest in the company’s products. Demand continues to be strong.

Nowadays, security and defense are key. With military spending at record levels, radars not only help protect expensive vehicles and infrastructure, but also countless lives of troops and civilians. Also, with numerous immigration crises around the world, RADA’s radars are instrumental in securing borders. Therefore, the growth of demand for radars is bound to continue. RADA’s specialization in compact tactical radars will position the company to win numerous programs in the future as the demand for radars grow.

Largely driven by US programs, the North American market accounted for half of RADA’s revenue in 2019. In the near-term future, RADA expects that US programs, specifically Bradley APS, IM-SHORAD, and GBAD will require over 1,650 radars in the near term. RADA saw great demand from European customers over the last couple of years, too. The European market made up 14% of 2019 sales, much higher than 1% just two years earlier. This illustrates strong global revenue growth from a diverse and growing customer base. No one customer accounted for more than a 12% share of sales in the last two years. RADA’s revenue growth is global, diversified, and healthy.

Valuation

Of course, valuations for growth companies are often a stretch and difficult to reconcile. In today’s market, companies like NVIDIA (NVDA), Shopify (SHOP), Tesla (TSLA), and Zoom (ZM) fly to seemingly stretched valuations with momentum carrying them forward. For me, RADA is a growth company at a much more reasonable price. Justifying the valuation is much easier, too. PE and PEG are the usual metrics, however, they will not work on RADA, since the company has yet to see the benefits of its growth translate to the bottom line. Operating losses quarter by quarter were reduced and finally turned positive in Q1 2020. Q2 2020 operating income had a significant increase, too.

Quarter Ending

6/30/19

9/30/19

12/31/19

3/31/20

6/30/20

CMGR

Revenue

10.0

11.3

14.4

15.1

17.5

15.0%

COGS

6.4

7.2

9.3

9.7

11.3

14.5%

Gross Profit

4.4

4.6

5.3

5.3

6.2

9.0%

SG&A

2.8

2.7

3.3

3.3

3.4

5.0%

R&D

1.7

1.9

2.0

2.1

2.2

6.7%

Operating Income

-0.8

-0.5

-0.2

0.05

0.6

Stock Price

$ 3.52

$ 4.76

$ 5.19

$ 3.50

$ 6.54

Price/Sales

3.75

5.07

5.10

3.07

5.18

Gross Margin

35%

35%

37%

41%

44%

Source: Data from Yahoo! Finance * In millions of $

The metric I use for RADA are Price/Sales. Without extensive historical data, we can’t use profits as a baseline. Price/Sales ratios help me ensure that the stock price doesn’t get too stretched in anticipation of profits down the road. Margins must stay constant or preferably improve to ensure the increased revenues create economies of scale. Consistent profitability should be right around the corner, but in the meantime, I want to make sure that RADA can grow revenues without hurting margins.

RADA’s benchmark over the few quarters has been a Price/Sales ratio of 5. Generally that is considered high for the big, traditional Aerospace and Defense contractors. However, Aerovironment Inc. (AVAV), Innovative Solutions & Support (ISSC), and ShotSpotter Inc. (SSTI) are small-cap companies in the same industry with Price/Sales ratios in a similar range. Relatively, RADA seems extremely cheap. Its current price at 5.8x sales buys you over 65% expected growth for next year and over 39% for the year after, much less than the above-mentioned companies. None of its three counterparts will have growth at those levels, yet they trade at such prices.

Company

AVAV

ISSC

SSTI

RADA

Market Cap

1.9B

125M

342M

302M

Sales Growth (Current Year)

9.60%

30%

9.50%

65.20%

Sales Growth (Next Year)

11.00%

?

14.40%

39.70%

Price/Sales

5.0

6.0

8.1

5.8

Gross Margin

42%

55%

61%

37%

Net Income (2019)

41.3M

3.0M

1.8M

-1.9M

Source: Data from Yahoo Finance

The counterargument is that the other companies have higher gross margins and RADA is yet to become profitable. However, greater revenue growth and improving margins may translate quickly to bottom line growth. The great news is that RADA’s gross margin is showing signs of improvement. Gross margin rose from 35% to 44% over the course of a year. With sales and gross margins improving at such rates, RADA is truly starting to look like a bargain at its current valuation.

Still, Price/Sales and gross margins are historical numbers. When evaluating a growth company, we need to see where it will be in the future. Let’s say that RADA achieves its projected growth and makes $100M in annual revenue for 2021. To be conservative, we will round down and keep the Price/Sales ratio at 5, which is where it hovered for the last several quarters. As shown by the companies above, companies in this industry may be valued at 5x sales with a expected growth rate around 10%. I believe RADA will see higher growth than 10% in 2022. Given these conservative estimates, this gives RADA a market cap of $505M, a 67% in stock share price, bringing it up to just under $12 a share.

Although it is tough to predict what the stock price will be in 2022 and beyond, I would be surprised if double-digit rate of revenue growth does not continue. Remember, many government programs are long-term agreements and last for years. RADA shouldn’t have major swings in revenue numbers. I am expecting that these large programs will provide a steady revenue stream for years to come. Hopefully RADA will be profitable within a couple of years. Strong results on the bottom line may provide the results needed to send the stock even higher.

Conclusion

RADA is a high-growth company with a cutting edge product line. The demand for its products will likely grow and RADA should be able to capture a big portion of the $5B radar market over the next decade. My analysis suggests that RADA is a bargain at its current price. Simply said, RADA is achieving incredible growth and I believe it is valued at an attractive price. While my projections put the share price at just under $12 in about a year and a half, anything can happen. A few major contract awards can help RADA solidify its high revenue growth for years to come. If RADA can sustain its high growth rate, my projection may be much too conservative. However, even if I am too optimistic with a share price appreciation well over 50%, even at lower prices, investors should be getting serious returns within the next couple of years and potentially beyond.

Personally, I am heavily accumulating shares under $7. While anything under $8 is still attractive to me, I am patient and wait for pullbacks, which do come periodically. I track RADA’s monthly and bi-monthly press releases on new orders to ensure that the growth is in line with my expectations.

All I can say is that I hope that RADA doesn’t fly under your radar, because it’s certainly on mine.

Disclosure: I am/we are long RADA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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