MDA Stock: Growth Boosted By The Telesat Satellite Contract

In my last article on MDA (OTCPK:MDALF) (TSX:MDA:CA) in September 2022, I had a Hold position, but, the stock which was trading at $5.8 at that time has since appreciated by more than 40% to $8.2. But, as shown in the chart below, it first bottomed to around $4.

Between then and now, a lot has changed especially in terms of revenue expansion, additional sales opportunities through the Telesat (TSAT) contract, and the acquisition of the satellite payload division of Satixfy (SATX) which should help MDA’s positioning in space-based digital communications, without forgetting CHORUS for intelligent imagery.

With this thesis, I’m aiming to provide an update on its double-digit revenue growth drivers, but, given that it operates in the capital-intensive space industry and suffered from a negative FCF margin in the third quarter of 2023 (Q3), I provide the broader picture, highlighting the amount of sales generated for each dollar spent on Capex (capital expenses).

Diversified in the Space Industry

First, MDA with a market cap of $1.34 billion is a leading manufacturer of satellite systems and provider of technology including robotics services for the space industry, with the presentation slide below showing its presence in different sectors of the space economy.

Empowered by such a diversified presence in the aerospace and defense industry, revenue grew to the tune of 21% YoY in Q3 to $150.7 million with 45% of sales being made up of Satellite Systems. Moreover, 29% were derived from Robotics and Space Operations, and 26% from Geointelligence, representing a relatively balanced split.

Looking at individual segments, it was Satellite Services that grew the fastest at 31.3%, driven by more contracts on new projects including the Globalstar (GSAT) constellation of satellites I already evoked in my previous publication. Now, Globalstar is a provider of satellite-based communications systems with 17 satellites that will be launched in 2025 to deliver iPhone-direct-to-satellite communications as part of its Apple (AAPL) partnership. This could just be the beginning with Globalstar planning to expand its constellation to 48 satellites.

MDA is also a partner in the Canadarm3 project whose expected launch date is 2026. Now, some will remember how the Canada Arm robotic arm was used to extract satellites from the space shuttle about fifteen years back as per the introductory image. Tellingly, a highly autonomous updated version (or the third version) of the robotic arm using AI-enabled systems will form part of the U.S.-led Gateway Lunar, as part of the NASA-led Artemis missions to return to the Moon. This is an ambitious project involving a small space station orbiting our Moon and NASA is working with several commercial and international partners.

The Capex Utilization

Now, MDA is a partner in this venture, with the projects it undertakes being mostly funded by either public authorities or private companies meaning that revenues are contract-bound, and can last for years with the cash released after the accomplishment of specific milestones. This is the reason the cash flow may not necessarily be smooth and vary widely from quarter to quarter. Hence, $22.1 million of cash was burnt (or used in operations) during Q3. After accounting for capital expenses, this resulted in -53.6 million of levered FCF which is illustrated by the dip in the grey chart below.

Therefore, because of this rather erratic FCF performance, other metrics are required to obtain an idea of the way the company is consuming capital for every dollar of sales generated. For this purpose, I have plotted the Capex (in orange) and sales (in blue) and this shows a rather disciplined expense contained within the $17 million to $33 million range while sales have been steadily progressing to reach the above $150 million mark in the latest quarter. Thus, from $4.33 of sales generated for every dollar spent on Capex in the September 2021 quarter, this figure has now increased to $5.32.

Therefore, coming back to profitability, having an FCF margin of -7% is not necessarily an issue here when considering the broader picture, or the sales vs Capex progression. Along the same lines, the two quarters preceding Q3 saw positive free cash flow.

Talking further diversification, in addition to performing contractual work, the company is also investing money in a development called CHORUS, its next-generation earth observation constellation for night and day imaging in all weather conditions. The launch is scheduled for the last quarter of 2025 and will be done by SpaceX (SPACE) and the services will be commercialized for maritime surveillance and land intelligence purposes.

Deserves Better with Foray in Satellite Communications

This development reminds me of Maxar Technologies whose high-definition images proved important in February of 2022 for the Ukrainian military to avoid a major setback by the invaders coming from the East. Subsequently, Maxar was acquired by Advent International (a private equity firm) in May last year for $6.4 billion, representing a cash-per-share premium of 129% to the closing price. Now, this elevated interest by private equity provides a glimpse of the opportunities in the global satellite imaging market sized at $3.27 billion in 2022 and expected to grow by 19.12% CAGR in the 2023-2030 period.

These mean additional sales prospects through CHORUS, signifying that the stock deserves to be traded at a premium in my opinion, in the same way as Lockheed Martin (LMT) and Raytheon Technologies (RTX) as shown below.

Thus, based on Raytheon’s price-to-sales of 1.86x, MDA is still trading at a discount of around 11%. Moreover, its track record shows a much faster revenue growth rate of above 30% (above table) together with the ability to surf on top of news-induced momentum like the 25% upside when it was awarded a contract of CAD$2.1 billion by Telesat to manufacture 198 LEO (low earth orbit) satellites. Thus, considering an 18% upside or the average of 11% and 25%, I have a target of $9.7 (8.23 x 1.18) based on the current share price of $8.23.

This bullish position is further justified by the acquisition of Satixfy Communications’ digital payload division for $40 million, which should further boost MDA’s positioning in the booming market for satellite-based communications solutions. In this case, in addition to Apple partnering with GSAT, T-Mobile (TMUS) has also inked a deal with SpaceX for space-to-ground signals to be beamed directly to mobile phones. Looking further, there are also Samsung Electronics (OTCPK:SSNLF) and Huawei.

Therefore, there are other opportunities in the context of MNOs (mobile network operators) extending their network to geographical areas that are too remote and costly to be connected through terrestrial infrastructure. Also, news about potential customer interest in CHORUS’s imaging products may help propel the stock.

MDA is a Buy but depends on the Backlog

However, $9.7 remains a long-term target, and, with demand already strong, I believe that the challenge has now turned to timely delivery to customers. This pertains to MDA’s ability to reduce its record backlog of CAD$3.1 billion (at the end of Q3) which is about five times its revenues for fiscal 2022 and represents a 121% increase from the December 2022 backlog of CAD$1.4 billion.

Now, while a large backlog provides a cushion against volatility in uncertain economic conditions where there is a higher probability of suffering from lower demand, things can be radically different in a high-demand environment. For this matter, Telesat had initially allocated the LEO satellite contract to Thales Alenia Space, a JV between French Thales S.A. (OTCPK:THLLY) and Italian defense conglomerate Leonardo (OTCPK:FINMY), but this was canceled after facing production issues.

Furthermore, after winning the Telesat contract, expectations levels have now gone high, prompting analysts to increase MDA’s consensus revenue estimate for fiscal 2025 from $801.14 million to $959.84 million as shown below.

Now, this is more than a $150 million increase from previous expectations, and, in case the company faces supply chain disruptions, it may miss deliveries, in turn resulting in a topline miss. In this case, as more attention turns to MDA’s production capacity, the stock can become volatile, and, for those who want to see progress on the backlog front, one metric to closely watch out for is the inventory level which stands at $7.8 million as of the end of the third quarter. This has to rise as the company stocks more components to support production of LEO satellites given the high contract value of CAD$2.1 billion.

In conclusion, this thesis has shown that the Canadian company is well diversified across different sectors of the space economy, and can sustainably increase the amount of sales out of every dollar spent on Capex while operating in a highly capital-intensive industry. Furthermore, the price target is much lower than the $12 reached in 2021 but is still a fair one given the high level of expectations can result in volatility. Also, the business of launching satellites can involve delays in case the launch window is missed, putting downward pressure on the stock.

Finally, looking at the balance sheet, the Canadian company had much more debt ($229.1 million) than cash ($9.9 million) at the end of Q3 but also had $239.7 million in total receivables which are future customer payments. To this end, its debt-to-equity ratio of 29.53 is lower than both Lockheed and Raytheon as shown in the peer comparison table above.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.