EQUITY RESEARCH Restructuring play (YE16 PT raised from 10.30 to 11.00; Rec. upgraded from Neutral to Buy) 4 4Q results to be a turning point: The market has already discounted that IDR will not meet its aggressive targets and the sentiment on the name seems to have touched bottom. This set of results should be the last kitchen sinking and we expect the company to provide more visibility on the short term outlook which is bound to be a strong positive trend. There are still some question marks, namely on the provision to be booked in Brazil and the outlook in the country, but we believe that this set of results will likely be the turning page for IDR and we expect market confidence to start building up from here. 4 Capital increase no longer seems an inevitability: As the company starts to show the first signs of recovery, we believe that a capital increase would be a good decision as it would improve strategic flexibility and market perception. Having said this, Net Debt by YE15 will be lower than we thought it would in the beginning of this process and we are more confident on CF conversion in the short term. Therefore, while before we saw a capital increase as almost inevitable we now believe it seems possible to go by without it. 4 Upgrading to Buy: We fine tuned our estimates and our macro assumptions increasing our YE16 Price Target to 11.00 (+7%). The stock is trading at a 35% discount to 2018 blended peers' P/E and historically has traded in line with peers leading us to believe that expected growth is not priced-in. Downbeat expectations, first signs of a positive trend approaching, fewer concerns on the CF front and an attractive valuation justify upgrading our recommendation to BUY. Indra vs. IBEX35 vs. 140 120 100 80 IDR Indra MSCI SC IBEX35 IT Buy Medium Risk 19th February 2016 Spain 60 Feb-15 Aug-15 Feb-16 Source: Bloomberg. Stock data Price (18 th Feb.): 8.38 Price Target (YE16): 11.00 Nr. of shares (mn): 164.1 M. Cap. ( mn) / F. Float: 1 376 / 63% Reuters/Bloomberg: IDR.MC/IDR SM Avg. Daily Vol. ( mn): 16 514 Major Shareholders: SEPI (20.1%); C. Alba (10.0%); TEF (3.2%) Estimates 2012 2013 2014 2015 F 2016 F 2017 F 2018 F PE Adj. 8.7 10.0 13.2-28.1 12.8 9.5 7.9 Dividend yield 4.0% 4.0% 0.0% 0.0% 0.0% 0.0% 0.0% FCFE Yield -4.6% 4.8% 1.1% -13.3% 0.9% 8.1% 13.5% FCFF Yield 2.3% 7.3% 10.4% -13.7% 7.3% 8.3% 10.3% PBV 1.3 1.3 1.3 2.1 3.4 2.7 2.1 EV/EBITDA (1) 7.5 7.6 8.1 19.8 8.3 7.0 6.3 EV/Sales (1) 0.8 0.7 0.7 0.8 0.8 0.8 0.8 (1) EV is fixed with current market cap and MV of remaining items. Historical Recommendation Recommendation 08-Sep-14 Reduce 08-Sep-15 Neutral 30-Nov-15 Reduce 20-Jan-16 Neutral Analyst Pedro Oliveira pedro.pinto.oliveira@bpi.pt Phone 351 22 607 3194 Available on our website: www.bpiequity.bpi.pt, Online, and Bloomberg at NH BPD
INVESTMENT CASE Revenues should still fall in 2016 Top line should continue under pressure as IDR reassesses its portfolio and reduces exposure to problematic contracts apart from FX headwinds. The company stated it wanted to reduce its exposure to low margin projects from 24% in 2014 to 11% by 2018 and the downward adjustment should be mostly done in 2015 and 2016 (revenues to fall 2.5% and 1.2%, respectively). Beyond 2016 we expect IDR to start growing top line, still we continue to deem highly unlikely that IDR will meet its 2018 revenue targets as it would imply revenue growth levels around 9% for 2017 and 2018. Our revenue estimates stand 11% below the company is mid-range target for 2018. Projects with low margins (% of sales) 30% Geographical breakown of revenues 2015 F 25% 24% 20% 15% 10% 11% 11% 5% 0% 2007 2014 2018E Source: IDR. Source: Equity Research The positive news is that the mix of revenues is improving, reducing the overall risks of the investment case. Spain & Europe accounted for 57% in 2013 and should account for 62% of total in 2016. Margins to grow materially in 2016 and 2017 Since the beginning of the year, Indra has reported astonishing low margins for an IT company with a Tech flavour. It is obvious the consolidated picture conceals a dual reality picture. Indra continues to have highly profitable lines of business with strong margins (though weaker than in the past) and other contracts with zero or even negative margins that have proved devastating for the company s profitability. The new management is committed to change this by focusing the company on profitable lines of business which together with an efficiency plan for the next years is bound to enhance margins materially. The margin enhancement goes hand in hand with revenue decline as Indra shuts down loss making business which justifies our scepticism on the company s top line targets. estimates vs IDR 2018 targets IDR GAP Revenues 2 990 3 357-10.9% Tech 1 336 1 321 1,1% IT 1 654 2 036-18.8% EBIT Rec. 278 352-21,0% EBIT mg 9.3% 10.5% -1.2pp Capex 67 63 6.9% FCF 225 200 12.5% Net Debt / EBITDA 1.3x 1.0x - Source: IDR & Equity Research. 2
The efficiency plan, including the ongoing personnel restructuring in Spain and Brazil, is expected to provide savings of around 190mn. Taking to in consideration that we expect a slight revenue growth for the period 2015-18 F (+ 126mn) the potential for margin repair is palpable. Despite our optimism in the trend, we remain more conservative on margins than the company forecasted in its Investor Day targets as we believe that a lower than expected top line is likely to take a toll on margins. We estimate an EBIT mg of 9.3% vs. the company target of 10.5%. Our EBIT stands 21% below the company mid-range target for 2018. Cash conversion to improve materially The focus on profitable lines of business should gear IDR towards projects with higher cash conversions which together with a tight WK management are bound to provide the needed oxygen that will reduce overall risk and lead investors to rethink the investment case. Cash conversion is the area where we believe the company is more likely to meet its targets as we believe the 200mn FCF were conservatively set and do not account for the tax shield IDR will benefit in coming years due to the amount of restructuring/provision charges it has booked in the recent quarters. We estimate 225mn recurrent FCF for 2018 (or 189mn if we exclude the tax shield impact) ahead of the 200mn target provided by the company. Cash conversion analysis ( mn) 300 250 200 150 100 50 0-50 - 100 2011 2012 2013 2014 2015 2016 2017 EBIT FCF cash conversion ratio 1.2x 1.0x 0.8x 0.6x 0.4x 0.2x 0.0x -0.2x -0.4x Capital increase still seems the best alternative but pressure is decreasing We continue to defend that a capital increase would be a good alternative to the equity story as it would improve strategic flexibility (for organic and inorganic growth) and would change faster the market perception on the name. Having said this, Net Debt by YE15 will be lower than we thought it would be in the beginning of this process and we see some signs that improve our confidence on CF conversion in the short term. Therefore, while before we saw a capital increase as almost inevitable we now believe it seems possible to go by without it. 3
Net liabilities evolution ( mn) 1 200 1 000 800 600 400 200 0 2012 2013 2014 2015 2016 2017 2018 Net Debt Factoring Net liabilities / EBITDA 10.0x 9.0x 8.0x 7.0x 6.0x 5.0x 4.0x 3.0x 2.0x 1.0x 0.0x Trading at a discount to most of its peers IDR is trading at a discount of 6% to the blended EV/Op.CF and 35% discount to the blended P/E for 2018. The additional leverage partially explains the gap between the two metrics but in 2018 the leverage has already been materially reduced. The main reason in our view lies with the fact that IDR has systematically presented a higher EBIT to earnings conversion than its peers. Moreover, IDR in the last 5 years has traded at an average 0.5% discount to the 12-month blended P/E and is currently trading at 1% premium to peers. We believe that as IDR delivers on its expected earnings growth the gap to peers' 2018 E P/E starts to narrow. Company 2018 targets if achieved would provide bulky upside The bullish case for IDR is in our view assuming that the company will be able to deliver its 2018 targets. Incorporating those growth and margins into our model, our fair value for the company would jump to 14.70/share, 76% above the current market prices. We continue to believe that the company s targets are overly optimistic but we also acknowledge that our estimates are somewhat conservative, namely on margins, and consequently we see more risks on the upside than on the downside for our numbers. 2018 Multiples of IDR vs. Peers EV/Op.CF P/E IT Atos 6,8x 8,7x Altran 8.0x 10.5x Average 7.4x 9.6x Tech Thales 8.9x 12.7x Ultra Electronics 9.9x 14.5x Bae systems 8.6x 8.9x Average 9.1x 12.1x Blended multiples 8.2x 10.7x IDR 7.7x 7.9x Upgrading to Buy We fine tuned our estimates and macro assumptions increasing our IDR's YE16 Price Target to 11.0 (+6%). Given the need IDR faces to de-leverage we maintain our Dividend Discount Model approach supported on a dividend policy that allows the company to reach Net liabilities (Net Debt + Factoring)/EBITDA of 0.9x. Change in estimates (%) 2015 2016 2017 Revenues -0.4% -0.4% -0.4% EBIT Rec. 22.8% 1.8% 1.8% Net Profit 5.4% 4.8% 3.3% 4
DDM - Gordon Model ( mn) Valuation Summary ( ) 2014 2015 2016 2017 2018 2019 2020 FCFE 47 38 167 192 225 193 207 Dividend 56 0 0 0 0 0 41 DPS 0.34 0.00 0.00 0.00 0.00 0.00 0.25 Pay-out FCFE 17% 0% 0% 0% 0% 0% 20% Pay-out 48% 0% 0% 0% 0% 0% 20% Net Debt 663 845 832 721 536 342 167 Net liabilities 850 1.018 1.005 894 709 515 340 Net liabilities / EBITDA 3.2x 8.6x 3.5x 2.7x 1.9x 1.4x 0.9x Source: IDR & Equity Research. Downbeat expectations, first signs of a positive trend approaching, fewer concerns on the CF front and an attractive valuation set a good entry point leading us to upgrade our recommendation to BUY. Equity Value (DDM) 1 753 Financial Investments 44 Total Equity 1 797 # shares (mn) 164 YE16 Price Target ( ) 11.00 DCF Assumptions Re 9.9% Rf (1) 4.3% Beta Equity 0,9 Market Premium 6.0% Rd 5% Tax marginal rate 25% Perpetuity NOPLAT margin 10.1% (1) Includes Country Risk Premium. DCF Sensitivity ( /share) EBIT mg -2% 0% 2% Rf -1% 10.80 13.20 15.50 + 0% 9.00 11.00 12.90 CrP 1% 7.60 9.30 11.00 5
4Q15 RESULTS TO BE A BOTTOM? The market has already discounted that IDR will not meet its aggressive targets and the sentiment on the name seems to have touched bottom. This set of results should be the last kitchen sinking and we expect the company to provide more visibility on the short term outlook. We expect top line falling 6.7% in the 4Q, as Brazil downward pressure persists and Spain presents a more negative trend due to tough comparables. However, Underlying EBIT should improve qoq as the restructuring plan and overall efficiency measures are implemented. We expect a recurrent EBIT mg of 4.4% (3.5% in Q3). Net profit will be impacted by additional provisions in Brazil (as announced by the company in the 3Q) which we conservatively estimate could be in the range of 80mn. We assume the cash outflow of this provision will be impacting 2016, 2017 and 2018. Our net profit estimate for the 4Q stands at -9mn. CF generation of the operations should be very strong in the 4Q compared to previous quarters benefiting from improvements in the WK management, which should be a one-off impact. On the other hand, IDR is expected to have had a cash outflow with the personnel restructuring in Spain of roughly 100mn in the 4Q. Consequently, we expect Net Debt to increase slightly qoq (+ 8mn). IDR should provide some guidance for the FY16 that should reflect a material uplift on margins as the restructuring program in Spain and Brazil should have already a material impact in 2016 and the provisions recorded will eliminate the overruns in Brazil & others from the recurrent EBIT. On the CF front we expect the company to set an improved trend for 2016 on the operational front, but we still expect non-recurrent items to represent 154mn of cash outflow in 2016. All in all, IDR earnings seem to have touched bottom and we believe the trend will be positive onwards. There still some question marks, namely on the provision to be booked in Brazil and the outlook in the country. Nonetheless, we believe that this set of results will likely be the turning page for IDR and we expect market confidence on the name to start building from here. Indra 4Q15 preview ( mn) Consensus Revenues 795 818 Rec. EBITDA 55 64 Rec. EBITDA mg 7.0% 7.5% Rec. EBIT 35 43 Rec. EBIT mg 4.4% 5.3% Net Profit -9 30 Source: Bloomberg, Equity Research. 6
Indra estimates breakdown mn 4Q15 4Q14 yoy Revenues 794.6 851.6-6.7% Rec. EBITDA 55.3 63.7-13% Rec. EBITDA mg 7.0% 7.5% -7% D&A -20.1-15.5 30% Rec. EBIT 35.2 48.2-27% Rec. EBIT mg 4.4% 5.7% -22% Non recurrent costs -94-230.5-59% EBIT -58.7-182.3-68% EBIT mg -7.4% -21.4% -65% Net financials -12-12.5-3% Profits of associates & others investments 5-4.4-224% PBT -65.4-199.2-67% Taxes 56.5 29.4 92% Minorities -0.2-0.6-66% Net Income -9.0-170.4-95% Source: IDR and Equity Research (F). Revenues ( mn) Transport and Traffic 189 189-0.1% Telecom and Media 73 89-18.3% P.A. and Healthcare 116 144-19.0% Financial Services 117 122-4.3% Energy & Industry 128 138-7.2% Security & Defence 172 170 1.2% Source: IDR and Equity Research (F). Revenues ( mn) Domestic 317 349-9,2% International 477 502-5,0% Source: IDR and Equity Research (F). 7
P&L CAGR ( mn) 2012 2013 2014 2015 F 2016 F 2017 F 2018 F 14-18 F Revenues 2 941 2 914 2 938 2 864 2 829 2 909 2 990 0% EBITDA 268 250 22-532 259 314 371 103% EBITDA adj. 300 278 268 119 285 335 371 8% EBITDA adj. mg. 10.2% 9.5% 9.1% 4.1% 10.1% 11.5% 12.4% Depreciation & others 51 52 64 85 95 95 93 10% EBIT 217 198-42 - 617 163 219 278 n.s. EBIT adj. 249 226 204 34 189 240 278 8% Net financial results - 18-47 - 33-36 - 33-36 - 37 3% Income Tax - 36-30 7 102-26 - 39-52 n.s. Others 1 2 3 4 5 6 6 19% Minority Interests - 5 1 2 0 0 0 0 n.s. Net Profit reported 133 116-92 - 570 87 128 173 n.s. Net Profit adj. 157 138 104-49 107 145 173 14% Balance Sheet CAGR ( mn) 2012 2013 2014 2015 F 2016 F 2017 F 2018 F 14-18 F Net Intangibles 926 892 873 746 743 741 741-4% Net Fixed Assets 166 158 127 121 91 63 37-27% Net Financials 69 79 90 90 90 90 90 0% Inventories 417 454 315 226 228 234 241-7% ST Receivables 2 176 2 060 1 841 1 668 1 673 1 721 1 761-1% Other Assets 185 151 140 145 145 145 145 1% Cash & Equivalents 70 363 294 264 238 202 172-13% Total Assets 3 756 3 865 3 481 3 273 3 200 3 154 3 101-3% Equity & Minorities 1 110 1 135 954 384 471 600 773-5% MLT Liabilities 700 1 037 912 1 164 993 829 599-10% o.w. Debt 398 790 826 867 824 700 490-12% ST Liabilities 1 946 1 693 1 616 1 725 1 736 1 725 1 729 2% o.w. Debt 305 196 131 243 247 223 218 14% o.w. Payables 274 271 273 261 258 265 272 0% Equity+Min.+ Liabilities 3 756 3 865 3 481 3 273 3 200 3 154 3 101-3% CF Statement ( mn) 2012 2013 2014 2015 F 2016 F 2017 F 2018 F + EBITDA 268 250 22-532 259 314 371 - Chg in Net W.C. 78 35-220 - 59-2 15 11 - Income Taxes 36 30-7 - 102 26 39 52 = Operating Cash Flow 155 186 249-371 234 261 308 - Growth Capex 105 21 25-48 62 64 67 - Replacement Capex 0 0 0 0 0 0 0 - Net Fin. Inv. - 2 11-1 0 0 0 0 = Cash Flow after Inv. 52 154 225-323 172 196 241 - Net Fin. Exp. 43 51 44 44 39 40 40 - Dividends Paid 56 56 56 0 0 0 0 +/- Equity 0 0 0 0 0 0 0 Other - 73-37 - 165 185-121 - 45-15 =Change in Net Debt 120-11 40 182-13 - 111-185 Net Debt (+)/Net Cash (-) 633 622 663 845 832 721 536 Growth per share data and ratios 2012 2013 2014 2015 F 2016 F 2017 F 2018 F Sales growth 9% -1% 1% -3% -1% 3% 3% EBITDA Adj. growth -4% -7% -4% -56% 140% 18% 11% EPS Adj. growth -13% -12% -25% n.s. n.s. 35% 20% Avg. # sh (mn) 164 164 164 164 164 164 164 Basic EPS 0.8 0.7-0.6-3.5 0.5 0.8 1.1 EPS Adj. Fully diluted 0.8 0.7-0.5-3.4 0.6 0.8 1.1 DPS 0.3 0.3 0.0 0.0 0.0 0.0 0.0 Payout 42% 48% 0% 0% 0% 0% 0% ROCE (after tax) 10% 9% -2% -37% 10% 13% 16% ROE 15% 13% 10% -8% 27% 28% 26% Gearing (ND/EV) 28% 29% 31% 36% 35% 31% 23% Net Debt/EBITDA 2.1 2.2 2.5 7.1 2.9 2.2 1.4 Source: Company data and Equity Research (F). 8
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