DNB Markets - IAR Systems: Insiders showing the way
While Covid-19 does not stop the increased security risks the IoT can present, nor developers’ need for the flexible design processes offered by RISC-V, we have cut our 2020–2022e EBIT forecasts by 19%. Still, as its legacy tools are system-critical for its OEM customers, we estimate its fair value at SEK150–230 (230–275) and note that the stock is trading at a P/E 2021e of 16x, a 40% discount to its historical average.
Potential Covid-19 impacts. It is still early days, but we believe sales processes in H1 2020 are likely to be delayed, with procurement departments working from home. For 2020, we expect this to translate into maintained demand for need-to-have development tools (i.e. IAR’s legacy Workbench licences) but postponed adoption for its new RISC-V tools and security products, given slower decision-making processes. Still, we like IAR’s resilient licence sales business model, which has high customer retention (95%) and ~35% recurring revenues, and highlight that its software tools are system-critical for its OEM customers’ product development. In combination with a digital distribution model (the bulk of sales stem from its website), we believe IAR Systems is well-positioned to face a deteriorating macroeconomic backdrop.
EBIT 2020–2022e down by 19%, to account for potential Covid-19 implications. In our view, the embedded systems market will likely weaken and the ramp-up of new product launches could be back-end-heavy for 2020e, with the turning point delayed into 2021e. We forecast -3% organic sales growth for 2020, with a V-shaped recovery in H2 2020 causing slight margin contraction, and an EBIT margin of 26% (down from 27% in 2019). While investment is likely to remain at elevated levels, we forecast average annual FCF of SEK60m+ over 2020–2022e and highlight that IAR is well-capitalised with net debt/EBITDA of 0.1x, as well as an unutilised SEK200m credit facility. Our base case is that IAR maintains its SEK3 DPS, though we do not rule out it could postpone its DPS decision until later this year when earnings visibility returns.
Fair value lowered to SEK150–230 (230–275), to reflect our updated forecasts, on which IAR is trading at a 2021e P/E of 16x, corresponding to a ~40% discount to its historical average. We see further valuation support from CEO insider buying.