Hexagon Q3'24: Spin-off could simplify company structure

Cyclical headwinds continued in Q3, and a material recovery might not yet take place in Q4. We estimate growth to rebound in 2025-26 as the relatively low comparison figures and lower interest-rates increasingly supporting industrial activity. Hexagon has enjoyed fast-growing SaaS revenue throughout the macroeconomic downturn of 2024, which could be further highlighted by the company’s plan to potentially spin-off some of these businesses. We reiterate our Accumulate rating with an unchanged target price of SEK 115.

Cyclical elements burdened growth despite continued increase in recurring revenue

Organic revenue growth in Q3 was -2% against tough comparison figures. Cyclical downturn in industries such as automotive and construction hurt especially hardware sales. Total sales growth was -4% in Q3 partly depressed by FX-changes. Sales were 4/2% below our/consensus estimates. Weaker-than-expected revenue was also reflected in adjusted EBIT, which was 6/3% below our/consensus estimates. Revenue quality continued to improve since recurring revenue growth was around 7% y/y, driven by SaaS. The improved revenue mix contributed to a significant increase in gross margin (67.1%, up 1.6pp y/y) and also supported adjusted EBIT, together with continued efficiency gains from the rationalization program. The rationalization program has now been concluded and according to Hexagon, it has achieved run-rate annual savings of 172 MEUR exceeding the target of 160-170 MEUR. We cut our 2025-26 adjusted EBIT estimates by 2-3% on account of the weakish Q3 report.

Innovation and market recovery to boost earnings growth by 2025-26

Hexagon’s forward-looking commentary did not bode well for an instant recovery in the company’s cyclical end markets, such as construction or manufacturing, which means that Q4 is likely to be another low-growth quarter. The management, however, highlighted the new products and features the company is launching in 2024 that could strengthen Hexagon’s position by 2025 as the market presumably recovers. We expect the lowered rate of increase to gradually boost demand for industrial investment from 2025 onwards, helping organic growth to improve to 6% in 2025-26 from the relatively low starting point of 2024 (long-term average has been 5%). The improvement in growth should give a boost to profitability as well, and we anticipate that adjusted EBIT will grow by 7-8% in 2025-26.

Plan to divest ALI division could allow more focused strategic development in the long term

Hexagon announced a plan to potentially spin off certain fast-growing, highly profitable, software-focused parts of the group into a new entity that could be listed in either the US or Sweden. According to the company, the separation would support the long-term strategic development of the two entities. Hexagon would be left with range of businesses including sensors and software used for reality capture and 3D data utilization, whereas the new entity would focus on efficiency-improving software tools for the design and management of mainly industrial facilities. Using a straightforward sum-of-the-parts calculation utilizing the valuation multiples of key peers, we calculate that the immediate valuation impact to Hexagon caused by the separation would be rather insignificant (+4% to the current share price). Value could be created over the long term, however, if the two companies can achieve better earnings growth separately through a better strategic focus. Hexagon currently trades at an adjusted EV/EBIT of 18x for 2024e and 16x for 2025e. We consider 18x to be a fair valuation multiple for this diversified, value-creating high-quality technology company. The estimated earnings growth of 7-8% for 2025-26 together with a 1.5% dividend yield results in an annual return of 9%. which we argue is attractive enough given the low business risk profile.