RADA Electronic Industries — Locked-on to a growth market

Mini tactical radars are an integral part of anti-drone and missile protection systems, a high growth, emerging niche within defense and security markets. Protection from unmanned aircraft systems (UAS) and protection of combat vehicles from ATGMs (also known as Active Protection Systems – APS) is an urgent priority for the US Army and other global armed forces. RADA’s combat experience, US presence, multi-integrator sales strategy and technical advantages ensure it is well positioned to participate in US Department of Defense (DoD) programs, which should translate into sizeable, consistent order flow if won. The counter UAS and APS markets are in their infancies and successful execution of these early projects should secure RADA’s position as vendor of choice in best-of-breed solutions.

RADA is an Israel based pioneer in the mini tactical radar market and recorded initial revenues in this business segment in 2017. This emerging segment of the global defense electronics market is estimated by the company at $5bn. Although sizeable, it is still niche in the context of the $1.8tn global defense industry and explains why RADA’s main competitors include IAI Elta (a government-owned Israeli company) and a handful of US (eg SRC) and other companies, rather than the tier one defense contractors such as Lockheed Martin, Northrop Grumman, Raytheon and BAE Systems.

Two of the US Army’s six major modernization priorities are in RADA’s domain: next generation combat vehicles and air and missile defense, with total spending of over $24bn expected by 2024. RADA radars are already integrated into the defense systems of the US Army Stryker for short-range air defense and are planned to be incorporated into the Bradley armored fighting vehicle for APS. The recent US Army announcement (July 2020) that RADA radars have been selected to be incorporated in the counter-small UAS interim solutions implies further contract wins. Aside from the US Army, the USMC and IDF are customers as well as other global armed forces and integrators.

Modernizing existing fleets of combat vehicles with APS (predominantly in the US and Israel) will drive near-term revenue growth, however the process of replacing the installed base of combat vehicles in several Western armies is gathering pace. For example, the US Army plans to award the first contract for next-generation prototypes in 2021 with a program budget of $45bn. Aside from the protection of combat vehicles, there is potential for RADA products to be used in the defense of mobile military forces, stationary military bases and national borders; these would require significantly more radars than the four deployed on each combat vehicle.

The longer-term potential for RADA in non-military markets is in its infancy, but with each appearance of an unwelcome drone or UAV at oil facilities, airports or even a royal palace, the need for anti-drone defense becomes clearer.

RADA revenues grew 58% in 2019 and we expect a further 61% increase in 2020 driven by growth in mini tactical radars primarily for customers in the US and Israel, while the legacy avionics business is expected to remain stable. Successful execution of the current order book, a strong balance sheet and an operational US facility position RADA well for inclusion in US Army production programs. This should lead to a ramp in orders to equip brigades rather than the current smaller number of units.

We expect RADA’s underlying EPS to grow by 106% in 2021 vs 19.2% average growth for the peer group. In order to smooth the near-term distortions, we use RADA’s five-year (2020–24) compound average EPS growth rate of 32.1%. This growth still represents a premium of 67% versus the peer group. Using RADA’s 2021 P/E multiple divided by the five-year compound average EPS growth we derive a PEG of 0.88x, a significant discount of 44% to the peers’ PEG of 1.57x. A share price of $10 would suggest a more reasonable PEG of 1.2x, still a 25% discount to the peer group.

Our DCF model implies a share price of $10 using a WACC of 7%. The assumptions used to support this are a CAGR in revenues (2020–24e) of 22.9% during our explicit forecast period and terminal growth of 2% pa. We also see cash flows being driven by margin expansion; in 2020 we forecast 10% EBITDA margins, however over the medium term we see upside to 18%. While US margins may be capped by inclusion in DoD serial production programs, there is margin upside for RADA in the rest of the world and in non-military applications.

Established in 1970 in Israel, RADA is a military technology company. Until 10 years ago it focused solely on avionics, providing recording, post-mission analysis as well as core avionics systems for integration in military aircraft and UASs. Avionics has limited growth potential and RADA locked on to the nascent, but growing niche of mini tactical radars. With combat experience, a successful track record and a recently operational US production facility, RADA is well positioned to become a key equipment supplier to production programs for the US DoD and to capitalize on other global growth opportunities.

RADA manufactures compact hemispheric radars (CHRs) and multi-mission hemispheric radars (MHRs) for use on combat vehicles, short-range protection for maneuvering forces and critical infrastructure. The software-based systems enable bespoke solutions that can be integrated with any command, control, communications, computers and intelligence system (C4I), other radars and sensors. The key difference between the CHR and MHR are the antenna sizes, which determine the maximal detection ranges. The systems use pulse doppler technology, which enables automatic and precise interception of incoming threats.

CHR sensors provide real-time target trajectory data to active protection systems (APS) that neutralize, where necessary, all threats (eg rocket propelled grenades and anti-tank guided missiles) to combat vehicles. CHR sensors detect, classify and track aerial threats such as drones and UASs, can be mobile or stationary and can be integrated with laser jammers and/or smoke detectors providing ‘soft kill’ solutions. RADA’s MHR suite is integrated into short-range air defense systems and Counter-Rocket, Artillery & Mortars (C-RAM) systems, detecting all aerial threats and computing the point of origin and point of impact of the C-RAM almost instantaneously.

RADA continues to develop its product suite, delivering one next-generation upgrade this year with three more expected in 2021. New products are not expected to alter the gross margin outlook but ongoing innovation and investment is critical for future contract wins, e.g. participation in modernization programs such as mobile short-range air defense systems (M-SHORAD) for the US Army is assumed to require next-generation products.

Inclusion in long-term production programs for the DoD (typically Programs of Record, PoR, or Other Transaction Authority, OTA) should provide RADA with recurring long-term revenues and there are likely to be economy of scale benefits. However, the DoD seldom allows suppliers to make excessive margins. Therefore, while we see EBITDA margin upside from current levels, the potential in the US for expansion above 15% is limited in our opinion. In the rest of the world and in non-military markets there is more margin upside potential as RADA and the integrators it works with will not be under the same constraints outside the US.

RADA is following a path that is well trodden by Israeli defense companies, ie taking technology that is battle proven in Israel to the US and globally. Currently, RADA has over 190 employees in Israel, with approximately one-third in research and development and engineering. In the US facility RADA Technologies (RTL), which became fully operational in 2020, there are 35 employees.

RTL adapts radars to US market requirements and provides infrastructure and support for US clients, and US customer orders are now satisfied from the RTL facility. Each of the Israeli and US manufacturing facilities has current capacity of approximately $100m worth of radar sales, while the company is in the process to double capacity at each site. Current year group sales are expected to be $72m and $107m in 2021 with approximately half from the US, therefore the capacity is sufficient for the near term.

The US represents 36% of the $1.8tn defense industry (Global Defense Budget Analysis – Forecast to 2028, Research and Markets) and as RADA’s foremost target market was the obvious location for RADA’s first international expansion. RADA’s US facility provides customer support, parts, maintenance and repair. Moreover, for RADA to be embedded in US military programs, the DoD has a strong preference for local production, maintenance and support. The local presence has also proved crucial for maintaining production and customer support during the COVID-19 pandemic.

The US Army Modernization Strategy (AMS) identified six priorities and a DoD funding requirement of $57.3bn from 2020–24 to achieve these targets. Two of these priorities are in RADA’s domain, next generation combat vehicles (NGCV) and air and missile defense (AMD), with total spending of over $24bn by 2024 on these programs.

The nascent stage of market development coupled with the urgent need means that purchase orders to date have mostly been made via available contract vehicles. This allows the DoD to carry out certain prototype, research and production projects without a lengthy approval process. RADA’s orders for the USMC have been on an urgent need basis. RADA’s successful performance to date in supplying radars to the USMC Ground Based Air Defense (GBAD) program and the US Army interim short-range air defense (IM-SHORAD) Stryker program position it well for the transition to production programs, in the form of PoR and/or OTA.

A PoR is a directed, funded acquisition program that provides a new, improved or continuing materiel, weapon, information system or service capability in response to an approved need. Once a program is approved by the US DoD Future Year's Defense Program (FYDP) it becomes a ‘line item record’ in the budget. The FYPD is updated twice a year, once in August/September to reflect the armed services Program Objective Memorandum and Budget Estimate Submission and in the following January it will be included in the President’s budget to be presented to Congress. OTA has similar allocations in the budget, and uniquely can transition rapidly from requirements into orders.

Government prime contractors bid on contracts directly from government agencies. After award, the prime contractor company is the entity that is legally responsible for all aspects of fulfilling the contract, interacting with the government customer, managing subcontractors, and meeting all program delivery requirements. RADA typically works with tier 2 integrators that in turn work with the larger prime contractors.

There are two near-term serial production programs that can each last five years or more, for which RADA is competing, the USMC GBAD and IM-SHORAD Stryker programs. The timing of the transition to production is expected by the end of 2020. The financial implications are increased visibility of recurring revenues and economies of scale, while advance payments should ease working capital pressure.

RADA does not provide revenue breakdown by line of business but has stated that the legacy avionics business had steady revenues of $10–12m in recent years. This business provides mission data and video recording, and post-mission analysis and debriefing for fighter and trainer aircrafts and core avionics for UAVs. Mini tactical radars first contributed to revenue in 2017 and have been instrumental in reversing the declining revenue trend and moving the company towards profitability.

The US accounted for 50% of RADA revenues in 2019 and Israel 28%. These two markets are likely to continue to dominate the top line, but there remains great potential for RADA in most Western markets as well as India. Israel Aerospace Industries (IAI) was the largest single customer in 2019 due to a surge in avionics orders. Rafael was the second largest customer and is a state-owned Israeli defense company that acts as an integrator for RADA products. Lockheed Martin is a customer of the avionics division with initial sales of radars as well.

RADA commenced mini tactical radars R&D in 2010 and initial revenues were only recognized in 2017. Winning contracts with clients such as the US Army, USMC and IDF in our view backs RADA’s claim to a superior price to performance ratio over rivals.

RADA estimates its total addressable market to be worth $5bn, encompassing upgrades to the installed base of armored fighting vehicles as well as next-generation fleets. The market can be divided into APS and short-range air defense (SHORAD). The APS market is estimated by RADA at $3bn, while the SHORAD market is estimated at $2bn. Both of these markets are split evenly between the US and the rest of the world. For the first half of this decade we expect RADA revenues to be dominated by SHORAD, with APS taking over the lead in the second half of the decade.

RADA’s go-to-market strategy is similar to the familiar ‘Intel Inside’ strategy, ie to sell via integrators as part of a best-of-breed open architecture solution, in RADA’s case, as a sub-contractor to any relevant weapon system. RADA’s ultimate strategic goal is to be part of large DoD programs. The move to production phase should lead to a significant ramp in orders to equip brigades rather than a small number of units, which has been the majority of cases for RADA so far.

Initial sales are often direct to a military customer for testing and then the customer will direct RADA to work with an integrator that is coordinating a total solution. The sales cycle is typically four quarters. Once RADA products are in serial production, it is common for end customers to look for integrators that adopt RADA products as part of a best-of-breed solution. RADA works with several integrators, as shown in the table below. This allows RADA to be involved in numerous projects without risking all on one system.

RADA is a relatively small piece in a much larger defense system and has a small but important role in several multi-billion-dollar military modernization programs. While understanding that these programs are large and of high priority is important, we are not able to derive the revenue opportunity for RADA from a top-down perspective due to insufficient disclosure from either the client or prime contractor.

RADA’s growth prospects derive from gaining market share in this critical market. Due to the sensitive nature of the business, disclosure on contract details is low; we base our near-term forecasts on prudent assumptions. We know that RADA is currently supplying the US Army, the USMC and the IDF (among others) with its products and has contracts that are either ongoing or due to commence within the next two years. This revenue breakdown provides a sense-check for our forecasts but comes with a number of caveats and assumptions:

While timetables may slip due to COVID-19 (see page 13) by a few months, the Congressional Research paper published in February 2020 estimated the first unit equipped dates for the IM-SHORAD US Army programs that RADA is competing in. Given the delays to the Bradley APS Phase II testing, the near term is likely to be dominated by SHORAD.

RADA’s largest single shareholder is DBSI Investments (15.7%), an investment vehicle controlled by RADA Chairman Yossi Ben Shalom and Barak Dotan that has holdings in 16 Israeli companies. DBSI first became a shareholder in 2016 with a $4m investment and provided RADA with a convertible loan to repay debt from the previous principal shareholder. Since 2016 DBSI has participated in subsequent secondary offerings.

Funds from recent secondary offerings in 2017 (raising $9.7m net), 2018 (raising $12.3m net) and 2020 ($23.5m net) have provided the capital for RADA to increase capital expenditure on manufacturing facilities in the US, research and development and working capital in its expansion in tactical radars.

RADA has been listed on Nasdaq since January 1985 and the average three-month daily volume is 323,068 shares or $2.5m per day at the current share price.

Dov (Dubi) Sella – chief executive officer: Mr Sella joined RADA in January 2003, serving as COO from 2003–07, then as chief development officer until 2016 and since then as CEO. Having served as a fighter aircraft navigator in the Israeli Air Force, Mr Sella served as director of avionics engineering and business development at Elbit Systems from 1982–87. Mr Sella has a BSc degree (cum laude) in computer engineering from the Technion in Israel.

Avi Israel – chief financial officer: Mr Israel joined RADA in 2017 as its chief financial officer. Prior to that he worked at Maman Group as its CFO as well as the CEO of Maman subsidiary Logisticare. Mr Israel has many years of experience in the IT and telecoms industries in both private and publicly traded companies. He holds a BA degree in accounting and economics as well as an MBA, both from Bar-Ilan University, and is a certified public accountant.

Yossi Ben Shalom – executive chairman: Mr Ben Shalom is co-founder of the DBSI Investment Company and is active chairman of a number of public and private Israeli companies. He was formerly chairman of Pointer Telocation, CEO of Tadiran and was an active director of numerous boards including Nice Systems and M-Systems, among others. Mr Ben Shalom holds a BA in economics and an MA in business management from Tel Aviv University.

Within this report we focus on RADA’s potential with US and other military programs for APS and SHORAD systems. These programs are either in the phases of testing or procurement and are therefore quantifiable and our near-term forecasts reflect these opportunities. Additionally, the focus on the US armed forces is instructive as they are often first adopters of new technologies, with other militaries following their lead, especially given that the same models of many combat vehicles have been supplied to the US Army and its allies over several decades.

Aside from the opportunity to equip tens of thousands of combat vehicles globally, the potential for RADA’s radars includes military bases, perimeter security, hot borders, critical infrastructure and heads of states’ defense. While longer-term potential use cases for RADA’s products are abundant, most are too early to include in our near-term forecasts but provide comfort regarding the longer-term growth potential of the company.

As recently as July 2020 Iran held large-scale military drills in the Persian Gulf using drones among other weapons in a simulated attack on a replica US aircraft carrier. According to the Iranian Revolutionary Guard’s news portal Sepah News, ‘several regiments from IRGC’s navy and aerospace divisions are participating in the high-profile military exercise, featuring missiles, vessels, drones, and radars.’ With enemies of the US using drones in military drills, drone defense systems are a natural priority.

The incident caused two nearby US military bases to be put on alert according to news reports. With little sophisticated anti drone/UAS defense systems, military bases are another potential market for RADA’s products. The US military has around 5,000 bases with around 600 outside of the US (source: The Pentagon’s New Generation of Secret Military bases, David Vine, 2012). Each base alone has the potential for using multiple systems.

The threat posed by drones to US military assets was also highlighted by the July 2019 incident in the Straits of Hormuz where an Iranian drone (according to US officials) approached within 1,000 feet of the USS Boxer (see news report). The drone was brought down by electronic jamming measures using RADA radars that were integrated into the anti-drone light marine air defense system (LMADIS) aboard the USS Boxer that was mounted on a dune buggy as shown below. This combat experience has proved beneficial for RADA when competing in subsequent tenders.

RADA’s radars are currently providing the ‘red alert’ system against mortars and rockets around the Gaza strip. In addition to short-range rockets and mortars targeting Israeli settlements, Israel has a long history of enemy drone infiltrations, the latest of which was in July 2020 whereby a drone from Lebanon flew into Israeli territory. The IDF said the drone ‘was neutralized using advanced technology.’ There have been other drone incidents across volatile borders such as North and South Korea, and India and Pakistan.

The longer-term potential for RADA in non-military markets is in its infancy but with each appearance of an unwelcome drone or UAV at an oil facility, airport or even a royal palace, the need for anti-drone defense becomes clearer. Unlike most potential competitors in commercial markets, RADA’s products are military grade and combat proven, which could be a distinct advantage.

The September 2019 drone attack that caused suspension for a few days of over half of Saudi Arabia’s oil production illustrated the need for protection of critical infrastructure against drones and cruise missile attacks. Such facilities may use defense systems such as patriot missiles, which have excellent range but are less effective against drones, and UASs that fly close to the surface.

The UK’s Gatwick airport was closed intermittently for three days in December 2018 following the sighting of a drone near a runway causing hundreds of flight disruptions and millions of dollars of losses for airlines. Other airports have also been disrupted in recent years including Newark, Heathrow and Frankfurt. With 17,678 commercial airports in the world (according to Airports Council International), the potential is clear.

In 2017, the US Army outlined its AMS to the US Congress, designed to maintain the US position as the globally dominant land power, ‘Ready to conduct Multi-Domain Operations across an array of scenarios in multiple theatres by 2035’ (US Army, 2019 Army Modernization Strategy: Investing in the Future). The Army identified six modernization priorities and funding requirement of $57.3bn from 2020–24 to achieve these targets.

Two of these priorities are in RADA’s domain, NGCV (with APS) and AMD (with emphasis on SHORAD and C-UAS), with total spending of over $24bn by 2024 on these programs. It is important to note that these programs are for the US Army alone and the military opportunity set for RADA also encompasses the USMC and other militaries, predominantly Western, around the world.

RADA’s entrenched market position was confirmed in July 2020 with the US Army announcement that RADA’s radars have been selected to be incorporated in the C-sUAS interim solutions such as the LMADIS along with other fixed solutions. RADA’s CEO Dov Sella commented that the US Army considered not just existing technologies but also ‘new and emerging technologies currently in development.’ This speaks to the next generation of products RADA is developing that are positioned for the US Army M-SHORAD, which will replace IM-SHORAD.

APSs were first used by the IDF during Operation Protective Edge in 2014 in Gaza. The IDF recognized the need for combat vehicle protection against incoming hostile fire in heavily built up areas. Subsequently, RADA’s radars, integrated with the IMI/Elbit Systems Iron Fist APS was selected by the IDF for the Eitan AFV. The Trophy APS System deployed by the IDF on the Merkava Mark 3 and 4 tanks was that of Rafael Advanced Defense Systems, also an Israeli company and the chief competitor to the Iron Fist APS. This combat experience gave both Israeli consortia an edge over rivals when competing for contracts internationally, primarily in the US.

In 2017 the US army initiated testing on three separate APS systems for three combat vehicles: the Trophy system (Rafael) for the Abrams M1A2 and Marine Corps M1A1 tanks, the Artis Iron Curtain APS for the Stryker fleet of vehicles and the Iron Fist – Light Decoupled APS (with RADA inside) for the Bradley family of vehicles.

The US Army completed Phase 1 Iron Fist APS testing on the Bradley in 2018 assessing technological maturity, performance and integration. In late 2018, the US Army decided to move ahead to Phase II testing (ie supporting urgent material release facilitating procurement) currently scheduled for full year 2021 (delayed from 2020 due to budget cuts) with first production likely to be in Q421 or 2022.

The US Army has stated that: ‘Army units intend to use Bradley vehicles equipped with Iron Fist APS to provide protected transport of soldiers, to provide over-watching fires to support dismounted infantry and suppress an enemy, and to disrupt/destroy enemy military forces and control land areas.’ The initial commitment is to deploy Iron Fist on one battalion of the Bradley, 155 vehicles, approximately 650 radar units estimated at a $20m opportunity for RADA commencing in Q421 and completed in 2023. Equipping the first battalion successfully may lead to Iron Fist deployment on other Bradly battalions.

Successful execution of the first Bradley battalion during 2022 may also give the Iron Fist system containing RADA products an advantage in becoming the APS of choice for the US Army fleet of Strykers. We expect to hear about further progress on testing for the Stryker in 2021. The first phase could be 1,200 units on approximately 300 vehicles, an opportunity for RADA estimated at $60m. So far, the US Army has tested three different systems including the Iron Fist, Trophy and the Advanced Modular Armor Protection – Active Defense System by UBT/Rheinmetall. None of the systems demonstrated performance and systems ‘maturity’. Successful deployment on the Bradley as well as Iron Fist’s weight advantage could prove critical in winning the Stryker program.

In August 2019, the Iron Fist APS system won a tender with the IDF to equip the next-generation Eitan Armoured Fighting Vehicle and D-9 Bulldozer. RADA is to supply radars for a few hundred vehicles with initial revenues in 2022 of approximately $5m.

The APS market is only just emerging and to highlight this it is worth considering that the US Army is looking to initially deploy the Iron Fist system in one battalion of Bradleys, which would represent 155 vehicles out of a total of 6,724 or just 2% of the inventory. While some versions of the Bradley cannot handle the additional APS weight, it should be noted that there are many other Bradleys in service in the US Marines as well as the rest of the world.

Similarly, the first phase of the Stryker program is approximately 300 vehicles, an opportunity of more than $60m and yet only 14% of the US Army fleet, again not including the other US forces or rest of the world opportunities. The market is nascent and successful execution of these early projects should secure RADA’s position as vendor of choice in a best-of-breed solution for many years to come.

The Bradley and Abrams have been in service for around 40 years and are reaching their technical limits (source: Congressional Research Service July 2020). The AMS calls for an optionally manned fighting vehicle (OMFV) to replace the Bradley, the Decisive Lethality Platform to replace the M-1 Abrams as well as three other combat vehicles. In previous attempts to proceed with a replacement of the Bradley, APS was included in the prototype specifications.

In April 2020, the US Army released new OMFV guidelines including a plan to ‘reduce foreign barriers to competition’ and ‘identify a pathway to integrate relevant but immature technologies’. RADA’s US presence and next-generation technologies under development (as recognized by the US Army announcement of July 2020) appear to position the company well for the OMFV process.

The US Army has accelerated the timetable and now plans to award the first contract for prototypes in the fourth quarter of 2021, with a second in 2023 followed by the award a single production contract in 2027 with the first unit equipped in Q228. The program budget is estimated to be $45bn (source: Congressional Research Service July 2020).

Other countries are also planning next-generation combat vehicles that will likely include APS and RADA has a high chance of involvement, eg the Eitan AFV in Israel (already confirmed), Australia, UK, Canada, Holland and Germany among others.

The roots of today’s healthy SHORAD market can be traced back to Russia’s annexation of Crimea in 2014 and the need for an upgrade to air defenses was highlighted by German Army Brig Gen Markus Laubenthal, who stated in Defense News that ‘Germany and the US have a credibility gap when it comes to the SHORAD portfolio…so between the assault rifle and the Patriot there is not enough between to tackle short-range air defense challenges’. The identification of the gap in SHORAD defenses prompted the US Army to build an IM-SHORAD solution.

RADA was an early mover in the mini tactical radar market and its products have been integrated in the LMADIS for the USMC since 2017. As previously noted (page 9), the LMADIS was involved in the USS Boxer incident in July 2019. This combat experience has supported RADA to be one of the leading radar suppliers in the SHORAD market. To date, RADA has delivered approximately 50 systems to the USMC as part of the LMADIS system and there is potential for repeat orders of 400 or more radars over the next two to three years.

RADA’s MHR system integrated with Leonardo DRS’s mission equipment package was selected to be part of the US Army’s IM-SHORAD installed on a Stryker vehicle. RADA has so far delivered 10 prototypes and is expected to produce radars for 144 vehicles over the next two years. The total size of this contract could reach 600 units, an estimated opportunity of $60m over the next three years. First production orders are expected by the company during the remainder of 2020.

Forming a key part of the US AMS is the air and missile defense vision that sees IM-SHORAD becoming M-SHORAD by 2028, as detailed in the US Army Air and Missile Defense 2028 report. Noting that today’s maneuver formations have limited ability to detect and engage aerial threats, forces are at risk of continuous surveillance and aerial attacks by UASs (source: Army and Missile Defense 2028, US Army). The M-SHORAD system on the Stryker will address these issues with new capabilities including the integration of laser technology and the new indirect fire protection capability (IFPC), which uses a kinetic missile interceptor among other technologies to provide multi-threat defense capabilities against cruise missiles, UAS Groups 2 and 3 and surface-to-air missiles.

RADA’s new products under development are designed with M-SHORAD in mind.

Core Avionics is RADA’s legacy business. It is stable and cash generative with turnover of $10–12m pa. This business provides mission data and video recording and post-mission analysis and debriefing for fighter and trainer aircrafts, along with core avionics for UAVs and helicopters. Over the past 25 years RADA has developed, fielded and supported a wide range of solid-state digital recorders, cameras and debriefing systems for aerospace and military applications. RADA has also been a developer and manufacturer of core avionics systems for over 35 years, offering a wide spectrum of military avionics systems designed for integration in new and upgraded military aircraft and UAVs worldwide. Key customers include the Israeli Air Force, Lockheed Martin, Israel Aerospace Industries (IAI), Boeing and Embraer, among others. Units are installed onboard the world’s most popular fighter jets including the F-16 and F-15, ensuring stable and repeat business.

While RADA retains first-mover advantage and claims price-to-performance advantages over rivals, there is no guarantee that RADA will maintain its position as a leading player. Much depends on continued product development, and RADA is in the advanced stages of next-generation tactical radars that aim to address future challenges at an affordable price-to-performance ratio. RADA continues to develop its product suite delivering one next-generation upgrade this year with three more expected over the next 12 months. New products are not expected to alter the gross margin outlook but are key to remaining a leading player and participating in future modernization programs such as M-SHORAD for the US Army (see page 12).

Due to continued consolidation in the defense sector, competition is likely to emanate from smaller emerging players rather than the large Tier 1 contractors such as Raytheon, Lockheed Martin etc; the market is currently too small to attract them. However, it should be noted that RADA’s key competitors are larger than it and can benefit from economies of scale and potentially can be more price competitive and use greater financial resources to cut RADA’s technological lead.

The major competitor for mini tactical radars is ELTA, a subsidiary of Israeli government controlled IAI. Historically ELTA had a monopoly on all radars in Israel and today ELTA produces a wide range of radars, while RADA is focused on the mini tactical radar segment of the market. The ELTA WindGuard system was deployed by the IDF on the Merkava and Namer armored fighting vehicles. The combat proven WindGuard was awarded a contract by Leonardo DRS as part of the Rafael Trophy APS system for the Abrams MBT.

SRC in the US is another competitor. It is a non-profit organization.

RADA’s growth has been accompanied by an impressive 5.2x gain for shareholders since January 2017. We expect underlying EPS to grow by 106% in 2021 versus 19.2% average growth for the peer group. However, we use RADA’s five-year (2020–24) compound average EPS growth rate, 32.1%, to smooth the near-term distortion.

This growth represents a premium of 67% versus the peer group, however the PEG (using 2021e P/E divided by the five-year compound average EPS growth of 32.1%) is just 0.88x, a discount of 44% In our view, a PEG of 1.2x or $10 per share would better reflect the 32.1% CAGR in EPS from 2020–24e.

Our DCF model implies a share price of $10 using a WACC of 7%. The assumptions used to support this are CAGR in revenues (2020–24e) of 22.9% during our explicit forecast period and terminal growth of 2% pa. We also see cash flows being driven by margin expansion; in 2020 we forecast 10% EBITDA margins, however over the medium term we see upside to 18%. While US margins may be capped by inclusion in DoD serial production programs, there is margin upside for RADA in the rest of the world and in non-military applications.

The initial contribution from mini tactical radars in 2017 reversed the declining revenue trend in the years 2014–16 inclusive. Revenues in the avionics business have stabilized in the range of $10–12m pa. RADA does not provide a revenue breakdown by line of business so assuming avionics contributed $11m in 2019, tactical radar revenues increased to approximately $33m in just two years from inception (predominantly the USMC GBAD and IDF contracts). The steady, upward climb in quarterly revenues, a 10% CAGR per quarter Q118–Q220, has moved RADA from operating losses to operating profitability in 2020.

On 12 August 2020, RADA released Q2 results and increased revenue guidance for the year to ‘over $70m’ from $65m. Revenues reached $17.5m in the quarter, growth of 75% year-on-year. First half revenues of $32.8m imply accelerating growth in the second half of the year to reach the new guidance. With the majority of the $49m new orders announced during the first half of 2020 to be delivered by the end of 2020, we believe that the new revenue guidance is achievable.

Adjusted EBITDA margins expanded to 10% in Q2 from 5.7% in Q1 as operating expenses grew just 4.7% sequentially, while revenue rose 16.2% quarter-on-quarter.

Net cash was $29.5m at the end of the second quarter, a decline from the $32.6m level at the end of the first quarter. Part of the reason for the decline in cash was due to a strategic decision to build inventory as a buffer in case of supply disruption; inventories rose to $26.5m in the second quarter from $20m the preceding quarter. As the inventory buffer is utilized towards the end of 2020 and into 2021 cash conversion will improve.

The construction of RADA’s US facility in Maryland was completed in 2019 following an investment of approximately $5m in 2018–19. With sales capacity of $100m in each of the US and Israeli plants and expected sales in 2021 of $100m, we are not expecting any major capex projects in the near future in excess of the current run rate of approximately $4m pa. If the US facility needs to be expanded, then the capex burden would be relatively light according to the company, ie $2m capex to sales capacity of approximately $100m. RADA may open local facilities in other countries at some stage.

Inclusion in serial production programs are likely to have a neutral impact on working capital requirements due to higher advance payments.

For 2021 we expect continued strong revenue growth to $107.4m, based on the contracts detailed in Exhibit 7. Underlying EPS growth is anticipated to more than double in 2021 to $0.26. With gross margins forecast to remain stable at 36%, the jump in earnings is due to the operating leverage as EBITDA margins expand to 13% from 10%.

Looking further ahead, serial production for the DoD should provide RADA with recurring long-term revenues and there are likely to be economies of scale benefits. However, the DoD seldom allows suppliers to make excessive margins; rather, cost savings are often shared above a certain level. Therefore, while we see EBITDA margin upside from current levels of 10%, the potential in the US for expansion above 15% is limited in our opinion. In the rest of the world and in non-military markets there is more margin upside potential as RADA and the integrators it works with will not be under the same constraints.