Codan’s Communication Upside

This story features CODAN LIMITED. For more info SHARE ANALYSIS: CDA

Codan has surprised with the performance of its metal detection business, but it is the company’s communications business that has brokers excited.

-Codan moves to high quality status
-Solid organic and inorganic growth opportunities in communication
-Stellar margin expansion underpins valuation

By Greg Peel

“Whether you’re on an outdoor adventure, an artisanal miner looking for gold or a humanitarian organisation clearing land mines in the world’s most challenging environments, our metal detectors give you the range, depth and reliability you need to change your fortune.”

Codan ((CDA)) has best been known as a company selling metal detectors via its MineLab business, as the above statement from the company’s website attests. But Codan also develops and sells radio communication solutions across the globe. This division took a big step up in 2021 when Codan acquired US companies Zetron and Domo Tactical Solutions (DTC).

If MineLab provides for clearing land mines in the most challenging environments, Codan Communications develops technology solutions to solve customers’ communications, safety, security and productivity problems in some of “the harshest environments around the world”, again according to the company’s website, providing tactical communication solutions that enable its customers to be connected, ultimately to support critical missions worldwide.

Codan’s customers include the military and special forces, intelligence agencies, border control and first responders. Long term customers include more than 20 key US government agencies as well as the “Five Eyes” intelligence communities.

Codan’s products are sold in more than 150 countries, with a global network of dealers, distributors and agents that allow the company to deliver solutions anywhere in the world, whenever needed.

Upside Surprise

Back in February, Codan surprised with its first-half FY24 result, leading to a share price pop of around 24% on the day. While the beat was ascribed mostly to better than forecast revenues and 49% growth in the metal detection business, brokers remained focused on the growth potential of the communications business.

Canaccord Genuity noted at the time the business was becoming “high quality” and the communications segment is “key”. Canaccord retained its Buy rating and lifted its target price to $10.83 from $8.17.

Moelis lifted its target to $10.22 from $8.52 but stuck with a Hold rating given the share price pop meant valuation was by now less attractive.

Not to be outdone, Macquarie lifted its target to $10.65 from $8.48, and retained Outperform.

Earlier this month, Macquarie pulled its rating back to Neutral, given the share price had now rallied some 31% from the first-half result release, bringing it within 10% of the broker’s total shareholder return valuation. But Macquarie had nothing but praise for the company.

High Quality

The communications segment remains on track to deliver 10-15% organic growth in FY24, Macquarie noted, with future growth to be driven by organic and inorganic opportunities. The broker echoed Canaccord Genuity in suggesting “quality is key”.

Management remains focused on high quality clients driving growth, Macquarie reported, with a material portion of revenue now generated from government and large business customers. Codan has also pivoted its exposure by geography over FY22-23. Africa comprised 26% of revenue in FY22 but dropped to 11% in FY23, while North America increased to 50% from 41% over the period and Europe to 24% from 17%.

The communications segment remains attractive for future growth, the broker suggested, both organic and inorganic, given Codan’s market share is single digits in all areas it participates in. The business now seems to have a proven process to assess potential M&A transactions and has completed four smaller acquisitions over the last three years.

Codan continues to look for suitable transactions that are larger, similar in scale to Zetron/DTC, most likely in North America or Europe.

And Codan has the balance sheet to achieve this.

Initiation

UBS’s M&A scenario analysis suggests Codan could add up to $2.00 or 17% to its valuation and 11cps or 20% cash earnings per share accretion from fully utilising its new $150m debt facility for bolt-on acquisitions. The successful -$159m acquisitions of Zetron and DTC have formed the bedrock of the communications division, UBS noted.

The opportunity now exists for Codan to utilise its conservative balance sheet for accretive bolt-on acquisitions that could further enhance the Zetron/DTC product suite, service offering and/or geographical reach.

UBS initiated coverage of Codan last week with a Buy rating and $13.10 target.

The broker’s thesis is underpinned by a strong 28% three-year forecast cash earnings per share compound annual growth rate, largely underpinned by around 150 basis points per annum earnings margin expansion, driving the communications division towards company targets of greater than 30% compared to 25% in FY23, alongside continued delivery of 10-15% organic revenue growth.

Over the last three years Codan has invested heavily into its communications fixed cost base, through Sales & Marketing and Product Development headcount, UBS notes. This has provided the segment with the appropriate scale to accelerate organic revenue growth.

The fixed cost investment has now largely matured, with the broker’s analysis suggesting the incremental earnings margins for communications should be in the range of 40%.

UBS points out its FY25-26 EBIT forecasts are 3-5% ahead of consensus, driven by higher incremental communications EBIT margin forecasts, but in line on earnings per share given higher interest/tax forecasts.

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