Middle East Unrest a Boon to Elbit Systems Beating Defense Peers

Elbit Systems Ltd. (ESLT), Israel’s largest non-government defense company, is beating global peers after sinking to a six-year low in August on prospects the developer of unmanned aircraft and night vision systems will receive more contracts as violence in the Middle East escalates.

The company, which depends on its home country for 25 percent of revenue, has rallied 21 percent since Aug. 28, compared with a 1.5 percent advance in the Standard & Poor’s 500 Aerospace & Defense Index and 8.5 percent increase for Israel’s benchmark TA-25 Index. The gains pushed valuations to 9.8 times estimated profits from 7.4, still a 23 percent discount to the average multiple for companies on the S&P Defense Index.

Increasing orders from the Israeli government will help Haifa-based Elbit compensate for falling revenue in the U.S. and Europe amid growing security threats on Israel’s borders as well as heightening tensions with Iran and the possibility of an Israeli strike, according to Citigroup Inc. Israeli Prime Minister Benjamin Netanyahu cited “security and economic” upheavals as his reason for calling early elections on Oct. 9.

“Tensions with Iran and the Arab spring are causing a rise in Israel’s defense budget and Elbit is well positioned to benefit from this,” Michael Klahr, a Tel Aviv-based analyst at Citigroup who has been recommending investors buy shares since May, said by phone on Oct. 10.“Even after the recent move, I see an upside to the shares.”

A Defense Ministry committee recommended on Aug. 19 increasing the defense budget by about 3.5 percent a year to 76.2 billion shekels ($19.8 billion) in 2017 from 64 billion shekels this year.

$420 Million Contract

Elbit received on Sept. 10 a $420 million contract from the Israeli Defense Ministry, as part of a larger $603 million deal to supply avionic services and systems.

The contract is “evidence of a strong local defense market,” Klahr, who has a 170-shekel target price for the shares, 19 percent higher than the closing price, wrote in a report dated Sept. 13.

Netanyahu displayed at the United Nations General Assembly in New York last month a drawing of a cartoonish, short-fused bomb to challenge the international community to shut down what he says is Iran’s effort to attain nuclear weapons.

“I can say that as long as I am the Prime Minister of Israel, Israel will not allow Iran to reach a military nuclear capability,” Netanyahu said in an Oct. 21 e-mailed statement.

Border Attacks

In Egypt, President Mohamed Mursi met with senior Hamas leaders earlier this year about an easing of the Gaza border restrictions, efforts that were stymied after an August attack on Egyptian guards near the Israeli border.

More than 65 rockets from Gaza hit Israel and the Israeli air force struck the Hamas-controlled territories four times today amid escalating violence in the past week. Netanyahu yesterday blamed Iran for being behind the escalating rocket attacks on Israel’s south. An Israeli soldier and three militants were killed in a firefight on the Egyptian border last month.

Elbit, which got 50 percent of revenue from the U.S. and Europe last year, is also hunting for new markets as American lawmakers plan to cut defense spending by at least $487 billion over 10 years and as gross domestic product in the 17-nation euro region stagnates amid a deepening debt crisis.

The company said today a unit in Brazil won a $25 million order to supply the Brazilian army with remote controlled weapon stations. The company said on Oct. 2 that it will supply technology to the Royal Australian Navy and announced on Sept. 23 that it will set up a training center for a Latin American air force.

‘Overshooting’

Elbit fell 0.3 percent to 142 shekels, or the equivalent of $36.77 at the close in Tel Aviv today. The New York-traded shares lost 1.1 percent to $36.46 at 11:06 a.m.

“There has been an overshooting of the stock and this is a good entry point for investors,” Tsahi Avraham, an analyst at Clal Finance Brokerage Ltd., said by phone on Oct. 10. “The last win in Australia is just a tip of the iceberg of their potential.”

While Elbit’s Israeli shares rallied 7.5 percent in September, the stock is down 8.6 percent in 2012 after the defense sector worldwide was hurt by budget cuts. The company’s stock was dropped from the MSCI World index at the end of August.

Shares slumped to 117.50 shekels on Aug. 28, the lowest level in six years, sending valuations to 7.4 times next year’s estimated earnings, a 19 percent discount to its one-year historical average.

‘Very Low’

Elbit said net income in the second quarter fell to $38.3 million from $38.9 million as revenue declined to $676 million from $692 million.

“Growth is expected to be very low because of budget cuts in Europe and the U.S.,” Ilanit Sherf, an analyst at Psagot Investment House Ltd. in Tel Aviv who reinstated a hold rating on the shares this month, said by phone Oct. 16. “Even if the company has managed to diversify sales to countries like India, Brazil and Australia, these markets could also see a slowdown.”

Elbit’s sales to Asia and South America rose 51 percent in the second quarter and accounted for 35 percent of total sales, up from 23 percent in the same quarter a year earlier.

The company said today that it received a $25 million contract for its remote controlled weapon systems from the Brazilian army, according to a PRNewswire statement.

Elbit’s focus on defense electronic systems, as opposed to defense platforms, such as aircraft or ships sold by the largest defense companies, gives it an advantage over peers, Avraham said.

Computer Terrorism

Israel’s National Cyber Bureau is developing a system to protect the nation from computer terrorism as attempts to attack the country’s systems have risen, Netanyahu said on Oct. 14.

Northrop Grumman Corp. (NOC), maker of the Global Hawk surveillance drones, reported on July 25 a decline of 7.7 percent in second-quarter profit a week after Lockheed Martin Corp. (LMT), the world’s biggest defense contractor, said it may have to dismiss about 10,000 of its 120,000 employees if Congress doesn’t avert defense budget cuts.

“The major defense cuts are in platforms and not electronic systems,” Avraham said. “There is a nice upside that can come from both product and geographical segmentation” for Elbit, he said.

To contact the reporter on this story: Shoshanna Solomon in Tel Aviv at ssolomon22@bloomberg.net

To contact the editor responsible for this story: Claudia Maedler at cmaedler@bloomberg.net

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