Elbit Systems Stock Drops 30% From Peak, Raising Investment Questions

Elbit Systems' stock is currently trading around $696, a decrease of over 30% from its recent peak of approximately $1,016. In Tel Aviv, the company's valuation has fallen to around 98 billion shekels from a high of over 140 billion shekels. While this decline might appear to present an investment opportunity, given Elbit's continued growth, record order backlog, and strong demand, it's crucial to consider the broader defense sector.

Globally, defense stocks have experienced significant downturns. Germany's Rheinmetall has lost about half its value from its peak, and Renk has also fallen by more than 50%. In the U.S., AeroVironment, a leader in drones and loitering munitions, saw a drop of over 60% at one point, with Kratos experiencing a similar decline. This trend follows a period where investors eagerly bought into defense companies anticipating increased defense budgets, with stock prices outpacing actual earnings.

Now, the market is demanding tangible results. While European defense budgets remain high and backlogs are substantial, the focus has shifted from government spending plans to the actual revenue generated by companies and the pace of that generation. For instance, Rheinmetall, despite a backlog worth tens of billions of euros, has seen its stock halve. In Israel, smaller and medium-sized defense firms have seen even sharper declines, with the local defense industries index down around 40% from its 52-week high. Companies like Elbit, with its extensive global operations, large backlog, and proven profitability, have weathered the storm relatively better.

Elbit Systems reported second-quarter revenues of approximately $2.29 billion, a 16% increase, and adjusted earnings per share of $4.14, exceeding forecasts. Its adjusted operating profit margin was 10.4%, and its order backlog reached about $32 billion, with roughly $13.5 billion expected to be converted into revenue by the end of 2027. Management indicated the current backlog provides visibility for about 18 months without new orders.

Despite the stock drop, Elbit Systems still trades at a premium. Its price-to-earnings ratio based on the last 12 months is around 49, projected to fall to 38-42 for the upcoming year. This valuation suggests the market anticipates continued rapid growth. In comparison, European defense companies like Italy's Leonardo, Germany's Rheinmetall, BAE Systems, and Thales trade at significantly lower forward P/E ratios, generally between 18 and 20. Elbit's premium is attributed to its growth rate, backlog, European exposure, and its advancements in areas like drones, electronic warfare, and defense systems, with laser technology being a significant future prospect.

The development of laser technology, particularly for countering drones and rockets affordably, presents a major opportunity. Elbit supplies the laser source for Israel's "Iron Beam" system and is developing a powerful airborne laser. While this technology could lead to substantial orders if successfully commercialized globally, its current contribution to profits is not yet reflected in the stock's valuation. The core question remains whether Elbit's growth will be fast enough to justify its current premium valuation, especially when compared to lower-valued European competitors.