In May I started reporting on MDA Space Ltd. (TSX:MDA:CA), (OTCPK:MDALF) with a Buy rating. After initially falling, the stock is now trading 12% higher and has a better yield than the S&P 500 at 7.5%. In this report, I will discuss the latest results and assess the continued attractiveness of the stock by updating my price target and rating.

Why is our MDA spatial analysis important for you as an investor?

MDA Space is one of over 100 names I track that benefit from a thorough qualitative and quantitative analysis process. With this analytical rigor, we analyze each individual company in our coverage portfolio and instead of comparing names, we have developed an analytical model that uses a wide range of input variables to provide each name with a valuation and a multi-year stock price target cadence based on a EV/EBITDA valuation compared to the company’s median EV/EBITDA multiple and the peer group multiple.

In addition to a multi-year price target based on these multiples, we also rate each stock using a scoring system that includes a combination of earnings growth, historical performance relative to the broader markets, and expected upside potential of the stock relative to the long-term historical index growth rate of the stock markets. This way, the names we cover benefit from a consistent approach to determining valuations and calculating stock price targets, and we don’t have to compare all 100 names in our portfolio to figure out which name is more attractive.

MDA Space faces margin pressure, but backlog and revenue growth are strong

On a trailing twelve-month basis, the backlog has quadrupled, driven by a C$2.1 billion order in 2023 to build 198 satellites for Telesat and a C$1 billion contract for the Canadarm3 flight system. Revenue grew 14%, and that’s a good growth number. Adjusted EBITDA increased 5% to $176 million, with margins down 180 basis points. That’s a significant decline, but margins are still above the 20% the company targets. The lower adjusted margins mainly reflect mix and a higher depreciable asset base included in selling expenses. We should also note that in many space companies, material and labor costs have increased significantly, which also puts pressure on margins. Adjusted net income showed 18% growth, which exceeds revenue growth. So the adjusted net profit margin has actually improved.

Looking at the quarterly numbers rather than the last twelve months shows 23% growth to $242 million with gross margin pressure due to mix and asset impairment. Adjusted EBITDA increased 21% to $48.7 million with moderate margin pressure, while adjusted net income for the quarter increased 7%. So just looking at the quarterly numbers gives a much better reflection of the company’s revenue growth while also capturing the reality of adjusted EBITDA growth despite margin pressure.

Year to date, we see significant improvements in free cash flow as it has increased from negative $2 million to $95 million. If we exclude growth CapEx, which gives us a number to assess cash generation for a stable business, free cash flow has increased from $79 million to $163 million.

MDA Space increases prospects for 2024 and is more promising

MDA Space has raised its revenue guidance by $70 million down and $10 million up, while raising its adjusted EBITDA guidance by $10 million down and capital expenditures by $10 million down. That’s not a huge increase in guidance. The higher revenue guidance should result in EBITDA of around $14 million, and that’s what we’re seeing in the EBITDA increase. More promising is the positive free cash flow expected for the year, which is a year ahead of plan. So, despite some margin pressure, the company is on track to hit its targets.

What are the risks and opportunities for the MDA sector?

The risk to MDA Space appears to be margin pressure due to higher labor and material costs. MDA Space is not the only company facing this pressure. Many companies involved in space and satellites are seeing a higher cost base. While margin pressure is evident, I believe there is more good than bad with MDA Space. Space is gaining momentum and the segment is maturing, and MDA Space has already made provisions for this with the launch of its Aurora and Skymaker product lines. The former aims to capitalize on a transition to digital space technology, while the latter offers products and services for space robotics. Particularly with the commercialization of space, I believe space robotics could offer solid growth opportunities, and with the product line established, MDA Space is positioning itself for this as well.

When we think about investing in space or space technology, many investors may think of SpaceX or young companies that are revolutionizing space. Many of the younger companies also carry some risk as their track record is unproven, although recent examples show that past performance is not an indicator of future success. What I like, however, is that MDA Space is not a new company. It was founded 55 years ago and has decades of experience in space. As a publicly traded company, it is relatively new, having gone public in 2021 after a consortium of companies bought it from Maxar Technologies, but that expertise in the field remains, and the company is doing well financially as well: it has a growing space market, expects positive free cash flow this year, and debt that is approaching historical levels.

MDA Space shares with significant upside potential

To determine multi-year price targets, the Aerospace Forum has developed a stock screener that uses a combination of analyst consensus on EBITDA, CapEx and free cash flow, as well as the most recent balance sheet data, cash flow statements and my assumptions on debt repayment, share repurchases and dividends. Each quarter we review these assumptions and update them accordingly. When necessary, we add our own estimates if important items such as acquisitions are not yet reflected in the estimates. The estimates are not based on the guidance of the companies we cover, but on a strong combination of consensus and my own estimates.

MDA Space had a strong first half of the year and on that basis, analyst estimates for EBITDA have increased by around 3%, while free cash flow generation is now expected to be around $100 million, against previous expectations of $21.5 million. This shows quite well that the growth the company can deliver is good and even stronger than originally expected. Taking 2024 earnings into account, the company is roughly fairly valued compared to its average EV/EBITDA multiple, but without factoring in a multiple increase, it has 38% upside to $15.70 and further upside through 2026. The absolute positive is the prospect of positive free cash flow generation. MDA Space has around CAD$400 million of debt due in 2027 and the positive free cash flow allows the company to gradually pay down debt, reducing interest income and improving its leverage. I remain confident that the company will either refinance or extend the credit facility, but we also see opportunities to reduce gross debt by generating free cash flow.

Conclusion: The investment case for the MDA space remains convincing

Despite some pressure on EBITDA margins, I believe MDA Space presents a very compelling investment case. The space market is challenging but growing, and with decades of experience and an attractive product and services portfolio, MDA Space is well positioned to benefit, while its free cash flow is likely to improve its leverage in the coming years. Therefore, I continue to rate the stock a Buy and increase my price target from $13.12 to $15.70.

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