Codan (ASX: CDA) has provided updated fiscal 2027 guidance. For the communications business, this includes modestly upgraded first-half revenue and full-year growth at the upper end of the previously announced 30%-40% range. It is also guiding a moderately upgraded first-half group net income.

Why it matters: The improved outlook for sales growth is due to exceptional demand for its drone communication devices. Active conflict is drone-intensive, with a need to replenish stocks regularly.

  • This is the second guidance upgrade for the communications segment in as many months, highlighting that sales to conflict regions are notoriously difficult to estimate. Nonetheless, we update our growth assumptions to the top end of guidance and estimate that at least half of fiscal 2027 sales are to customers engaged in conflict.
  • We lift our fiscal 2027 adjusted EPS by 2% due to improved revenue growth and net income assumptions for the communications segment. After that, our estimates are largely unchanged.

The bottom line: Our fair value estimate is unchanged for narrow-moat Codan. Minor near-term modeling changes to revenue growth are immaterial.

  • Shares are expensive, trading at more than double our valuation. We believe the market is extrapolating the current pace of drone communication sales growth, seemingly assuming active conflicts, including the Iran and Russia-Ukraine wars, to persist over the long term.
  • Conversely, we expect a step down in drone communication sales over fiscal 2028-29, with sales retracting from current conflict-fueled levels and normalizing at 13% thereafter, at the midpoint of the company’s 10%-15% long-term sales target. This assumes most future sales are supporting defense customers to maintain inventory, rather than for use in active conflict.

Bulls say

  • Growth in emergency call center software is underpinned by the US government’s next-generation 911 software mandate, requiring upgrades of old technology and increasing the value of the addressable market.
  • Strategic acquisitions support bundling and cross-selling to existing customers, while opening the company to new customers.
  • Despite historical gross profit margins in the mid-50s, we expect further improvements from operating leverage as Codan increases sales volume and steady subscription revenue from call center customers.

Bears say

  • Metal detection sales are exposed to cyclicality, with a pullback from customers at low points in the economic cycle.
  • Geopolitical tensions could result in global military customers shifting purchasing to their own countries.
  • Codan competes with other technology providers. A new technology introduced by a competitor has the potential to make Codan’s technology redundant.