DNB Markets - IAR Systems: Dent in turnaround trajectory

IAR Systems’ Q4 report was a slight hiccup in its accelerated profitable growth turnaround, but we still expect it to see 45%+ EBIT growth YOY in 2023e with relative insulation from support and updates at ~40% of net sales, and durable design activity as developers choose IAR’s tools to boost productivity and the cost of ownership. We reiterate our SEK140–250 fair value.

Q4 sales in line with our forecast but operating leverage declined to 7%. IAR reported Q4 organic sales growth of 7% YOY (from 11% YOY in Q3 and 14% in Q2), which led to net sales 1% above our forecasts. We expected SEK2.1m of security sales, which were SEK0.2m, while IAR had also categorised ~SEK2.3m of security sales incorrectly in Q3, denting our short-term expectations. Adj. EBIT was 28% below our forecast (15.2% margin, down 1.4%-points YOY), resulting in a poor 7% incremental margin from ~25–50% seen in recent quarters. Adjusting for higher depreciation related to new office leases (~SEK3m) and an incentive programme (~SEK1m), we believe the underlying EBIT margin would have been 19.2% (up 2.6%-points YOY). Cash flows were soft in Q4 (cash flow from operations declined 36% YOY) to set up an LTM cash conversion of 90%. IAR proposed a 2022 SEK1.5 DPS (our estimate: SEK1.64) after two years of no dividends, which should take its net cash to SEK143m by end-2023e.

We have cut 2023e EBITDA by 2%, EBIT by 8%, and EPS by 10%, to factor in: 1) softer ramp-up assumptions for security sales; 2) higher investment in modernising internal processes, systems, and the UX/UI of the Embedded Workbench; 3) higher D&A from new office leases; and 4) higher interest costs. For 2023, we forecast 8% organic net sales growth YOY (split 5% YOY development tools and SEK15m in security solutions (3% of group net sales).

Fair value of SEK140–250 reiterated, corresponding to a 2023e EV/EBIT of 15–28x. IAR Systems is trading at 16x 2023e EV/EBIT (or 14x EV/EBIT and 6.5% FCF yield excluding Secure Thingz). We believe management's ambitious ramp-up of security sales for 2023e could be twice as high as our forecasts, but should it not materialise, we believe there is industrial interest in Secure Thingz's IoT security technology, with either outcome potentially acting as a catalyst for the business over the coming years.

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Best regards 
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Joachim Gunell | DNB Markets | Equity Research Sweden
E-mail: [email protected]