US investors’ enquiries should be directed to Santander Investment Securities Inc. (SIS) at (212) 692-2550. US recipients should note that this research was produced by a non-member affiliate of SIS and, in accordance with NASD Rule 2711, limited disclosures can be found on the back cover. European Equity Research Spain – Software & IT Services September 28, 2015 INDRA BUY Addressing Issues and Moving Forward CURRENT PRICE: €9.38 TARGET PRICE: €11.44 We have updated our estimates and target price to include 1H15 results and ≈70% of the company’s savings plan. We upgrade our recommendation to Buy from Hold, based on Indra’s clear determination to address the key pending issues: (1) cost-cutting plan to improve margins and cash flow conversion; (2) commitment to increase transparency to better align management remuneration with investors’ interests; and (3) consolidation of domestic (40% of sales) macro recovery. Restructuring plan emerging; personnel cost savings from 4Q15. Indra’s €180-200mn cost-cutting plan is expected to be implemented by the end of 2016. The core –and more credible part– of this plan is the personnel cost optimization of €120mn (with a short payback of ≈1.3 years). This is already underway, after the company reached an agreement with the unions. We expect the first savings in 4Q15E and the full impact in 2H16E. Increased transparency and management remuneration more closely aligned with investors’ interests. Indra’s transparency has improved with the new chairman. The company has made an effort to explain its difficult situation and to align management remuneration with investors’ interests (for instance, 70% of the annual variable remuneration is now linked to FCF and the EBIT margin, (instead of revenues), and 50% of long-term variable remuneration will be paid in shares (vs 25% previously). The risk-reward balance seems more positive. After the recent correction, we see a downside risk of ≈13% to our bear case, ≈21% upside to our base case and ≈58% upside to our bull case. Risks: (1) Cash flow pressures. Net debt rose to €825mn in 1H15, which implies 5.9x recurrent ND/EBITDA LTM and c3x based on our 2016E numbers). A capital increase cannot be ruled out; however, with a clear restructuring plan, it could reduce the company’s risk profile. It would also increase flexibility for bolt-on M&A and strategic R&D, so it should be positive from a fundamental point of view. (2) Execution risk implied in implementing the new plan, in particular in Brazil (10% of sales), where execution could be more difficult than expected. What Has Changed Relative Performance (12 Months) Source: FactSet. Vicente Martín (+34) 91 289 3914 [email protected]Robert Jackson (+34) 91 175 2537 [email protected]Company Data, September 22, 2015 Source: FactSet. Source: Company data and Santander Investment Bolsa estimates. Rating: Target Price: To Buy from Hold To €11.44 from €11.00 65 70 75 80 85 90 95 100 105 110 Sep-14 Dec-14 Mar-15 Jun-15 Sep-15 Indra (Rebased) IBEX35 (Rebased) Reuters/Bloomberg code Market cap (€ mn) Outst shares (mn) Free float (%) Avg daily vol (€ mn) 12-month range (€) Historical volatility (%) Implied volatility (%) Performance (%) -1M -3M -12M Absolute -5.5 -5.1 -17.4 Relative to IBEX35 1.6 12.9 -5.3 38.9 17.6 7.57 - 11.52 44.4 IDR.MC / IDR SM 1,540 164 50.0 (€ mn) 2013 2014 2015E 2016E 2017E Revenues 2,914 2,938 2,819 2,761 2,843 EBITDA 278 268 150 295 327 EBIT 226 204 61 222 251 Net profit 116 -92 -516 121 146 EPS (€) 0.71 -0.56 -3.14 0.74 0.89 Net debt 623 663 934 854 721 FCFE 48 90 -264 80 133 EV/EBITDA (x) 8.5 9.8 16.6 8.2 6.9 P/E (x) 15.0 -21.1 -3.0 12.7 10.6 GDY (%) 3.2 2.9 0 0 0 FCFE yield (%) 2.8 4.7 -17.2 5.2 8.6
Transcript
US investors’ enquiries should be directed to Santander Investment Securities Inc. (SIS) at (212) 692-2550. US recipients should note that this research was produced by a non-member affiliate of SIS and, in accordance with NASD Rule 2711, limited disclosures can be found on the back cover.
European Equity Research Spain – Software & IT Services September 28, 2015
INDRA BUY
Addressing Issues and Moving Forward CURRENT PRICE: €9.38 TARGET PRICE: €11.44
We have updated our estimates and target price to include 1H15
results and ≈70% of the company’s savings plan. We upgrade our recommendation to Buy from Hold, based on Indra’s clear determination to address the key pending issues: (1) cost-cutting plan to improve margins and cash flow conversion;
(2) commitment to increase transparency to better align management remuneration with investors’ interests; and (3)
consolidation of domestic (40% of sales) macro recovery.
Restructuring plan emerging; personnel cost savings from 4Q15. Indra’s €180-200mn cost-cutting plan is expected to be implemented by the end of 2016. The core –and more credible part– of this plan is the personnel cost optimization of €120mn (with a short payback of ≈1.3 years). This is already underway, after the company reached an agreement with the unions. We
expect the first savings in 4Q15E and the full impact in 2H16E.
Increased transparency and management remuneration more closely aligned with investors’ interests. Indra’s
transparency has improved with the new chairman. The company has made an effort to explain its difficult situation and to align management remuneration with investors’ interests (for instance,
70% of the annual variable remuneration is now linked to FCF and the EBIT margin, (instead of revenues), and 50% of long-term variable remuneration will be paid in shares (vs 25% previously).
The risk-reward balance seems more positive. After the recent correction, we see a downside risk of ≈13% to our bear case, ≈21% upside to our base case and ≈58% upside to our bull case.
Risks: (1) Cash flow pressures. Net debt rose to €825mn in
1H15, which implies 5.9x recurrent ND/EBITDA LTM and c3x
based on our 2016E numbers). A capital increase cannot be ruled out; however, with a clear restructuring plan, it could reduce the company’s risk profile. It would also increase flexibility for bolt-on M&A and strategic R&D, so it should be positive from a fundamental point of view. (2) Execution risk implied in
implementing the new plan, in particular in Brazil (10% of sales), where execution could be more difficult than expected.
Source: FactSet. Source: Company data and Santander Investment Bolsa estimates.
Rating:
Target Price:
To Buy from Hold
To €11.44 from €11.00
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Sep-14 Dec-14 Mar-15 Jun-15 Sep-15
Indra (Rebased) IBEX35 (Rebased)
Reuters/Bloomberg code
Market cap (€ mn)
Outst shares (mn)
Free float (%)
Avg daily vol (€ mn)
12-month range (€)
Historical volatility (%)
Implied volatility (%)
Performance (%) -1M -3M -12M
Absolute -5.5 -5.1 -17.4
Relative to IBEX35 1.6 12.9 -5.3
38.9
17.6
7.57 - 11.52
44.4
IDR.MC / IDR SM
1,540
164
50.0
(€ mn) 2013 2014 2015E 2016E 2017E
Revenues 2,914 2,938 2,819 2,761 2,843
EBITDA 278 268 150 295 327
EBIT 226 204 61 222 251
Net profit 116 -92 -516 121 146
EPS (€) 0.71 -0.56 -3.14 0.74 0.89
Net debt 623 663 934 854 721
FCFE 48 90 -264 80 133
EV/EBITDA (x) 8.5 9.8 16.6 8.2 6.9
P/E (x) 15.0 -21.1 -3.0 12.7 10.6
GDY (%) 3.2 2.9 0 0 0
FCFE yield (%) 2.8 4.7 -17.2 5.2 8.6
2
INDRA AT A GLANCE
Investment Case
Indra’s investment case is based on a restructuring plan to improve efficiency and being selective in new contracts, which together should translate into margin and cash flow improvements.
Key Value Drivers
New management’s determination to improve the company’s situation. A restructuring plan to reduce costs by €180-200mn is already in place and is due to be fully implemented by end 2016 .
The new strategic plan to refocus the company’s business model and concentrate on its core solutions, where the company is a reference worldwide.
A management incentive plan that is more closely aligned with minority investors’ interests, including more variable remuneration, with a higher proportion paid in shares and linked to different performance targets (FCF, margin).
Investment Risks
At the end of 2Q15, net debt rose to €825mn (or (€1.0bn including factoring). This implies 5.9x recurrent ND/EBITDA LTM (last 12 months).
Execution risk in implementing new business plan.
Brazil execution issues in particular could be more difficult than expected.
Catalysts
Cash flow and margin improvement.
Effective implementation of new strategic plan.
Consolidation of the macroeconomic recovery in Spain and recovery in Brazil.
Company Description
Indra is a technology company that provides business solutions, IT services and integrated systems to customers around the world: Close to 60% of its business is international. It has subsidiaries in 45 countries and projects in 128. Indra has a differential business model based on its own solutions (64% of total revenues) with leading clients in some industries. Revenues reached €2.9bn in 2014 with more than 39,000 employees. The company is organised around six vertical markets: Defence & Security; Transport & Traffic; Energy & Industry, Telecoms & Media; Finance & Insurance and Public Administration & Healthcare: It was floated in March 1999 at €4.47/share.
Key Company Data
(€ mn) 2012 2013 2014 2015E 2016E 2017E
P&L ACCOUNT
YoY growth (%)
Revenues 9.4 -0.9 0.8 -4.0 -2.1 3.0
EBITDA -4.3 -7.3 -3.6 -44.2 97.3 10.9
EBIT -7.1 -9.1 -9.8 -69.9 261.0 12.9
Net profit -26.8 -12.7 NM NM NM 20.5
Margins on sales (%)
EBITDA 10.2 9.5 9.1 5.3 10.7 11.5
EBIT 8.5 7.8 6.9 2.2 8.0 8.8
Net income 4.5 4.0 -3.1 -18.3 4.4 5.1
FREE CASH FLOW (€ mn)
Operating Cash Flow 130 112 147 -196 150 208
Cash flow from op activities 222 243 285 91 301 313
FCFF (unlevered) 83 99 137 -203 138 184
FCFE (levered) 43 48 90 -264 80 133
WORKING CAPITAL
Change in working capital (€ mn) -78 -35 17 -58 6 -14
as % of group sales -2.7 -1.2 0.6 -2.1 0.2 -0.5
NET DEBT & LEVERAGE RATIOS
Net debt 633 623 663 934 854 721
Net debt/(cash) to EBITDA (x) 2.1 2.2 2.5 6.2 2.9 2.2
Net debt/(cash) to equity (%) 58.2 55.4 70.5 220.0 156.6 104.3
CAPITAL EMPLOYED (€ mn)
Year-end 1,926 1,905 1,649 1,461 1,452 1,465
RETURNS (%)
ROCE (year-end) 10.1 9.4 11.5 4.0 12.4 13.5
VALUATION MULTIPLES (x)
Market cap-based multiples
P/E (reported) 10.6 15.0 -21.1 -3.0 12.7 10.6
P/BV (reported) 1.3 1.6 1.7 1.6 3.6 2.8
FCFE yield (%) 3.0 2.8 4.7 -17.2 5.2 8.6
GDY (%) 7.8 3.2 2.9 0 0 0
EV-based multiples
EV/sales 0.7 0.8 0.9 0.9 0.9 0.8
EV/EBITDA 7.1 8.5 9.8 16.6 8.2 6.9
EV/EBIT 8.6 10.5 12.8 40.4 10.8 9.1
Source: Company data and Santander Investment Bolsa estimates.
3
VALUATION
RISK-REWARD BALANCE LOOKS MORE POSITIVE
We have looked at historical multiples for the last ten years as a reference for average
multiples to apply to Indra and set a valuation framework.
Figure 1. Indra – P/E and EV/EBIT (x), 2006-15
Source: Santander Investment Bolsa estimates.
Given the size of the company’s recent changes, we have built various scenarios to establish a
valuation range and base-case TP for 2016E, based on different assumptions of revenues and
margins for 2017E. Our base case assumes revenues will decline in 2015E and 2016E, with
margins of ≈8.0% in 2016E and 8.8% in 2017E. It foresees the company achieving ≈70% of its
optimization plan, vs ≈ 47% in the bear case and 100% in the bull case.
Figure 2. Indra – Valuation Scenarios for 2016E
(€ mn, based on 2017 forecasts) Bear Case Base Case Bull Case
EV/EBIT (x) 11.4 11.4 11.4
P/E (x) 15.5 15.5 15.5
Revenues 2,760 2,843 2,929
EBIT margin (%) 7.3% 8.8% 10.3%
EBIT 202 251 302
Net income 108 146 187
EV based on EV/EBIT multiple (x) 2,305 2,861 3,449
Equity based on P/E multiple (x) 1,675 2,251 2,898
Net debt 2016E -854 -854 -854
Factoring -187 -187 -187
Other -13 -13 -13
Equity (2017) based on EV/EBIT (x) 1,252 1,808 2,395
Equity (2017) based on P/E multiple (x) 1,675 2,251 2,898
Equity(2016) based on EV/EBIT (x) 1,158 1,672 2,215
(1) Adjustments: we include inventories, clients, onerous projects, impairment of intangibles, other impairments and provision reversals for project risk provisions, and exclude tax credit impairment, goodwill impairment and onerous provisions of 98mn for current projects included in the balance sheet in 1H15. Source: Santander Investment Bolsa estimates.
This analysis suggests that the average underlying EBIT margin over the period was around 5.6%.
The third approach is to see if there are any EBIT margin references from peers. Indra is not a
pure IT company, nor is it a pure defence or transport player; it is a combination of segments
and niches of the latter two. Having said that, looking at potential ‘peers’, including Cap
Gemini, Thales, Atos and Tieto, the reported margin range for these companies in 1H15 was
6.0%-8.7%, so, bearing in mind the limitation of this analysis, we see our numbers as
achievable taking into account the company’s optimization plan and the different business mix
vs peers.
7
INCREASED TRANSPARENCY & MANAGEMENT REMUNERATION MORE ALIGNED WITH
INVESTORS’ INTERESTS
Since the appointment of the new chairman, Indra’s transparency and communication have
improved with an attempt to explain the company’s difficult situation and work being carried
out on new plans to solve existing issues:
(1) The Chairman has admitted several company issues: lower profitability in Brazil and Spain
and execution issues on several projects. The company included extraordinary charges of
€313mn (provisions, impairments and project cost overruns) with FY14 results which had
almost no impact on the financial position (cleaning up some previous excesses) leading to
FY net losses of €92mn. In 2Q15, the company announced €390mn in additional charges
related to cost overruns on some projects, mainly Brazilian operations, the consulting
subsidiary and other operations.
(2) Give the company’s situation, the new Chairman decided to implement a new strategic
plan as soon as possible in order to improve profitability and address company issues.
(3) For the first time, Indra held an Investors Day in order to explain its new strategy, and mid-
term targets. In addition to this, in recent quarters the company has organized results
conference calls.
Regarding remuneration policy, the company has implemented a new compensation system
adapted to international standards and more aligned with shareholders’ interests.
(1) The board reduced its remuneration by 20% and the new Chairman’s global remuneration
was reduced by 22.5%.
(2) Variable remuneration will now amount to 75% of the total and fixed remuneration 25%.
(3) The annual variable retribution will now represent 35% of the total (vs 50% previously)
with 70% of this linked to FCF, the EBIT margin and order intake targets. Long term
variable remuneration will now represent 40% of the total (vs 25% previously). In addition
to this, 1/3 of variable remuneration will be deferred by three years.
(4) Additionally, part of the deferred remuneration plus total long term variable remuneration
will be paid in shares that will account for 50% of the total vs 25% previously. The shares
will be held whilst the employee remains in the company.
8
UPDATING ESTIMATES
We have updated our estimates to include 1H results and the new strategic plan. Our 2018
numbers represent around 70% of the company’s mid-term guidance targets.
We cut our underlying EBIT estimates for 2015E by more than 50% to reflect weak 1H results.
We increase our mid-term (2016E-18E) EBIT estimates by 10% to partially reflect the new
strategic plan. Our 2018E numbers are equivalent to around 70% of company guidance (≈9%
EBIT margin in 2018E vs 10%-11% and FCF of ≈141mn vs the company target of €200mn).
Net debt at end 2015E should increase by >40% to €934mn (vs our previous estimates) to
reflect strong cash flow pressures and also cash outflows (€150mn, we have included €100mn
in 4Q) to pay the restructuring plan.
Figure 5. Indra – Change in Estimates, 2015E-19E
(€ mn) 2015E 2016E 2017E 2018E 2019E
REVENUES
Old 2,935 3,039 3,148 3,250 3,345
New 2,819 2,761 2,843 2,935 3,020
Change (%) -4% -9% -10% -10% -10%
EBIT
Old 131 204 224 238 257
New 61 222 251 263 273
Change (%) -53% 9% 12% 10% 6%
NET INCOME
Old 59 116 133 146 160
New -516 121 146 158 166
Change (%) -975% 4% 9% 9% 4%
Source: Santander Investment Bolsa estimates.
UPDATING OUR DCF VALUATION
Following the changes in our estimates, we have also updated our 10-year DCF valuation, after
rolling over our model to 2016. We maintain a cost of capital of 8.2% and a g of 2% with a
Working capital Stability in term of days of sales –
Stable capex
Capex will remain stable, increasing new digital
business, less requirements in traditional business –
FCF target ≈€200mn
Source: Company data.
If the company successfully executes and delivers on its ambitious targets it could continue as
it expects with no need for a capital increase or rapid deleveraging.
Could we see a capital increase? We believe that the company has a tight B&S situation,
offering limited room for manoeuvre if something unexpected happens (for instance Brazilian
execution issues increase or a couple of large projects with execution issues arise, or
restructuring affects the delivery of some projects, etc.). In addition to this, if the company
generates FCF over the next few years (at least in 2016E-17E), this would have to be used to
repay debt (to achieve a more normalized debt situation of ≈2x Net Debt to EBITDA on our
numbers) with limited room for additional investments. In our view, this seems a disadvantage
compared to its main peers that have net cash today.
We would prefer management solved the company’s remaining problems and focused its
efforts on improving company execution and obtaining some B&S flexibility to cover potential
needs (for example to acquire companies and technologies that could strengthen its position in
strategic niches or markets, or increase R&D on some strategic projects if needed; for instance
developing new core solutions or improving current ones, and new digital solutions, etc.),
improving the company’s core product portfolio/market situation. In this situation we believe
that a potential capital increase, together with a clear strategic plan that is already well
understood by the market, could help to reduce the company’s risk profile and, in our view,
could be favourably received by the market.
14
ZGOTO
IMPORTANT DISCLOSURES
The views expressed in this report accurately reflect the personal views of the undersigned analyst(s). In addition, the undersigned analyst(s) has not and will not receive any compensation for providing a specific recommendation or view in this report: Vicente Martín and Robert Jackson.
The analysts referenced in connection with the section for which he or she is responsible may have received or will receive compensation based upon, among other
factors, the overall profitability of Grupo Santander, including profits derived from investment banking activities.
Grupo Santander may have a financial interest in the issuers/companies mentioned in this report, including a long or short position in their securities and/or options, futures or other derivative instruments based thereon or vice versa. Information relating to this is available upon request.
Grupo Santander is a market maker or a liquidity provider for the financial instruments of Indra.
Grupo Santander may, in the last twelve months, have solicited or performed investment banking and/or underwriting activities and/or other services (including acting as adviser, manager, or lender) for any issuer/company referred to in this report which may have given rise to a payment or promise of a payment in relation to these services. Information relating to this is available upon request.
Key to Investment Codes*
Rating Definition
Covered with
This Rating
Provided with Investment
Banking Services in the Past 12 Months
Buy Upside of more than 15%. 44.59 17.57
Hold Upside of 10%-15%. 39.19 16.89
Underweight Upside of less than 10%. 16.22 4.05
Under Review 0 0
% of Companies
NOTE: Given the recent volatility seen in the financial markets, the recommendation definitions are only indicative until further notice. (*) Target prices set from January to June are for December 31 of the current year. Target prices set from July to December are for December 31 of the following year.
This report has been prepared by Santander Investment Bolsa, S.V., S.A. and is provided for information purposes only. Santander Investment Bolsa, S.V., S.A. is registered in Spain and is authorised and regulated by the CNMV.
This report is issued in the United States by Santander Investment Securities Inc. (“SIS”), in Spain by Santander Investment Bolsa, S.V., S.A. (“SIB”) under the supervision of the CNMV and in the United Kingdom by Banco Santander, S.A., London Branch (“Santander London”). SIS is registered in the United States and is a member of FINRA. Santander London is registered in the United Kingdom and subject to limited regulation by the Financial Services Authority, UK (“FSA”). SIS, SIB and Santander London are members of Grupo Santander. A list of authorised legal entities within Grupo Santander is available upon request. This material constitutes “investment research” for the purposes of the Markets in Financial Instruments Directive and as such contains an objective or independent explanation of the matters contained in the material. Any recommendations contained in this document must not be relied upon as investment advice based on the recipient’s personal circumstances. The information and opinions contained in this report have been obtained from, or are based on, public sources believed to be reliable, but no representation or warranty, express or implied, is made that such information is accurate, complete or up to date and it should not be relied upon as such. Furthermore, this report does not constitute a prospectus or other offering document or an offer or solicitation to buy or sell any securities or other investment. Information and opinions contained in the report are published for the assistance of recipients, but are not to be relied upon as authoritative or taken in substitution for the exercise of judgement by any recipient, are subject to change without notice and not intended to provide the sole basis of any evaluation of the instruments discussed herein. Any reference to past performance should not be taken as an indication of future performance. This report is for the use of intended recipients only and may not be reproduced (in whole or in part) or delivered or transmitted to any other person without the prior written consent of SIB. Investors should seek financial advice regarding the appropriateness of investing in financial instruments and implementing investment strategies discussed or recommended in this report and should understand that statements regarding future prospects may not be realised. Any decision to purchase or subscribe for securities in any offering must be based solely on existing public information on such security or the information in the prospectus or other offering document issued in connection with such offering, and not on this report. The material in this research report is general information intended for recipients who understand the risks associated with investment. It does not take into account whether an investment, course of action, or associated risks are suitable for the recipient. Furthermore, this document is intended to be used by market professionals (eligible counterparties and professional clients but not retail clients). Retail clients must not rely on this document. To the fullest extent permitted by law, no Grupo Santander company accepts any liability whatsoever (including in negligence) for any direct or consequential loss arising from any use of or reliance on material contained in this report. All estimates and opinions included in this report are made as of the date of this report. Unless otherwise indicated in this report, there is no intention to update this report. SIB may make a market in, or may, as principal or agent, buy or sell securities of the issuers mentioned in this report or derivatives thereon. SIB may have a financial interest in the issuers mentioned in this report, including a long or short position in their securities and/or options, futures or other derivative instruments based thereon, or vice versa.
15
IMPORTANT DISCLOSURES (CONTINUED FROM PREVIOUS PAGE)
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