The state budget law for this year does not include the significant cut in personal income tax approved just before year-end. Therefore, in the coming months, the government will present a new proposal that will imply higher CZGB issuance. In our view, this year's public finance deficit will prove similar to last year’s, as will net CZGB issuance. Due to the high expected CZGB supply and heavy redemption calendar, ASW seasonality will be amplified in 1H. The deterioration in public finances keeps alive the risk of a rating outlook downgrade. In the middle of the year, we will find out whether the Czech Republic will again be included among the developed economies in the GBI index family, and if it is, this would likely mean a significant outflow from the bond market. Domestic banks will likely remain the main buyer of CZGBs, to the detriment of foreign investors.  We recommend selling the CZGB 2031 in ASW.

The state budget law for this year does not include the significant cut in personal income tax approved just before year-end. Therefore, in the coming months, the government will present a new proposal that will imply higher CZGB issuance. In our view, this year's public finance deficit will prove similar to last year’s, as will net CZGB issuance. Due to the high expected CZGB supply and heavy redemption calendar, ASW seasonality will be amplified in 1H. The deterioration in public finances keeps alive the risk of a rating outlook downgrade. In the middle of the year, we will find out whether the Czech Republic will again be included among the developed economies in the GBI index family, and if it is, this would likely mean a significant outflow from the bond market. Domestic banks will likely remain the main buyer of CZGBs, to the detriment of foreign investors.  We recommend selling the CZGB 2031 in ASW.

We initiate coverage of small firearms manufacturer Ceska zbrojovka Group SE (CZG), with a Buy rating and target price of CZK357, implying a 12m TSR of 27.9%.

We initiate coverage of small firearms manufacturer Ceska zbrojovka Group SE (CZG), with a Buy rating and target price of CZK357, implying a 12m TSR of 27.9%.

CZG is one of the leading European producers of small firearms and the largest manufacturer of firearms in the Czech Republic. The company is active worldwide, with its most important markets being the US, the Czech Republic and the EU. We believe the company has strong growth potential, especially in the US. The company is in a good position to maintain profitability in our view and to continue to generate a high level of cash flow.

The US market is the largest in terms of volume and demand and is generally expected to grow at a strong pace over the near-medium term (see page 28). CZG aims to gradually increase its market share in the US, which is the world’s largest market for small firearms, and has planned to build a new firearms factory there to enable it to better serve its customers. This should also allow CZG to compete in government tenders in the military and law enforcement segments. We believe the new facility will likely help CZG increase its market share and lead to further sales growth.

CZG also has ambitions to grow in market segments other than firearms and is aiming to expand its business in the ballistic and tactical equipment sector. CZG holds a 100% stake in 4M Systems, which designs, manufactures and sells tactical and ballistic equipment.

M&A potential CZG often emphasizes the important role played by M&A in supporting further growth. Management’s vision is for a company that is a one-stop shop, meeting demand from all market segments (firearms, accessories, equipment, ammunition etc.). We see M&A activity as one of the potential factors propelling further growth and expansion. The small firearms market remains crowded and highly competitive and CZG wants to play a major role in any possible market consolidation. We see further opportunities for it to acquire ammunition companies, for example, or specialised accessories companies.

Attractive financial profile, dividend potential CZG’s low debt and strong cash flow generation, together with expected rapid future growth, creates the opportunity for an attractive dividend payout.

Our CZK357 TP is derived from a DCF model. At our TP CZG would trade at 14.6x P/E 2020e, 16.3x (2021e), and 8.2x 2020e EV/EBITDA and 8.5x 2021e. We use a WACC in the range of 8.1% to 9.8% depending on the year and a terminal growth rate of 2%.