Good morning, everyone, and welcome to the next presentation of today's German Select Conference. I'm happy to welcome Johannes Braun, Senior Investor Relations Manager of TKMS. A housekeeping note. The conference is being recorded, and all participants are on a listen-only mode. If you have questions for the Q&A session after the presentation, please submit them using the chat box. Now let's get started. Johannes Braun, the floor is yours.
All right. Thanks for the introduction. Thanks everybody for joining, and your interest in TKMS. I guess in the next 15 minutes or so, I will walk you through our business model, also where TKMS stands today, and then what we expect for the future. On slide two, this is a very high-level overview of what we do. I guess most of you will know that we are selling conventional submarines to the German Navy, but also to other navies worldwide. Actually, we are the market leader in conventional submarines, with 70% of the NATO fleet coming from us. We also produce surface vessels. That's basically our second reporting segment. Surface vessels is basically frigates that we sell. As you can see on the right side, often overlooked, our third segment, which is Atlas Elektronik.
Overall, we have some 185 years of experience in that business. We have currently 9,000 employees. Our sales have been EUR 2.2 billion. Those EUR 2.2 billion, you can basically say that 50% of those are generated in the Submarine segment, 25% Surface Vessels, and then another 25% in Atlas Elektronik, roughly. I will come to financials also later. Slide three just shows you the growth potential of our markets. I guess you are well aware that defense budgets are growing strongly worldwide. This is basically shown on the left side here, but on the right side, you can see how this is basically translating into the growth of our industry. 8%, roughly, we expect overall in our business in terms of the overall market growth. Slide four. You can see a bit more detail on our segments here, starting with the Submarine segment.
Basically, in the submarine segment, we have three product types in our portfolio. The 209 is the one that we are exporting to other countries and other navies since many years. A bit more advanced is the 214 class. Our most advanced product currently is the 212CD class, which we are currently selling to the German Navy, but also to Norway, and hopefully also soon to Canada. As you can see on that slide, we have the Stargazer. The Stargazer is basically an unmanned submarine, which is currently under development. In the surface vessel segment, on slide five, here we have different classes of frigates that we sell, which basically differ in size and also capabilities. The largest one is the MEKO A-400, which is basically an air defense frigate. We are currently offering that ship to the German Navy. We also have the MEKO A-200.
This is basically a smaller ship and more focused on anti-submarine warfare. This one has been sold to several navies already in the past, and is currently sold to Egypt. We also have a preliminary contract to sell this one to the German Navy as well. We also have the A-100, which is even a bit smaller, on the left top here, that small little picture there. That one is currently sold to Brazil. Lastly, what you can also see on that slide on the bottom right, that's basically the only civil project that we currently have, which is the Polarstern, basically an icebreaker. Slide six, this is Atlas Elektronik. As I said, this is a segment which is often overlooked in our portfolio, but it's a very important segment for us. At Atlas, we are selling sonar systems, combat systems for submarines, and also for frigates.
We're also selling here underwater drones, mine hunting systems, and also torpedoes. This segment actually has the highest growth rate in our business and, at the same time, with more than 10%, also the highest margins. You can see that this is a very important segment for us. Slide seven. You can see an overview of what we do in terms of unmanned vehicles, also a very important growth area for us. Some products like the little unmanned speedboat that you can see on the left side, and also the SeaCat, are already in deployment in several navies, for example, in the Ukraine.
While some others, like the MEKO S-X, which is basically a half-dive vessel, and also the SeaCat, which, as I said, is an unmanned submarine, are still under development.
You can imagine with manpower being the key bottleneck for several navies, such unmanned products are in high demand currently. I move over to slide number eight, and that's basically one of the most important slides in my presentation because it basically shows you in a nutshell where TKMS stands today and what the pipeline is. On the left side, you can see once more what we basically do, basically what we just discussed, but what you can also see is the current order backlog. This stands currently at more than EUR 20 billion, so almost 10x our annual revenues. The main building blocks of this backlog are firstly the six submarines that we are currently selling to the German Navy. This is the Type 212CD that I mentioned. We are selling another six ships to the Norwegian Navy, same type, Type 212CD.
We are also selling six submarines to a conventional customer that I cannot name. What we also have in our order backlog is the Polarstern, the icebreaker. This are the main building blocks for the EUR 20 billion. What you see then on the right side is the campaigns that we are currently running. Those campaigns are basically projects that are not yet in the order backlog, but will be in the backlog once we have finalized the contracts. Here first we have India. We are in the final negotiations with India for six submarines plus three as an option. We are in the final round here, so there's no competitor left. Relatively likely that we get the contract. We have Canada. Canada is very important for us. For Canada, we are offering up to 12 212CD submarines.
Here, we still have one competitor left. Officially, it's a 50/50 chance, but we are hopeful that we conclude this also successfully. What you also see here is eight ships that we are offering to the German Navy in terms of the F127 frigate, a very important air defense frigate for the German Navy. No competitor here left. It's only us that can basically provide those ships. Here the question is also rather when and not if we are getting the contract. Lastly, what you also see here is the MEKO A-200. I already mentioned that one as well. We are offering this to the German Navy as well currently, at least four ships. Here we are also quite confident that this will concluded in a successful way.
The key point here is that if you take the value of all those campaigns together, they have the potential to easily double our order backlog from the current 20 billion to more or less 40 billion then. So a significant potential to further increase our order backlog. Moving on to slide nine. This just quickly shows you the latest numbers that we have published for the last fiscal quarter, which was Q1 for us. EBIT at EUR 26 million for a margin of 4.8%. I think worth noting here is that Q1 is typically our lowest margin quarter, so we'd really expect our margin to increase as we move through the year. And then slide 10, also I think a very important slide because I think it's important to understand the way our balance sheet is structured.
The key thing here to understand is that we are always in a negative working capital position. This is due to the prepayments that we receive from our customers. In other words, our projects are always overfunded at every stage of the project. Furthermore, we have no significant financial debt apart from some pension provisions. We are also in a net cash positive position in terms of the balance sheet. Moving on to our guidance framework on slide eleven. For this year, we are guiding for revenue growth of up to 5% and an EBIT margin of more than 6%. In the midterm, once our new orders are fully ramped up, we are expecting revenue growth of 10% per year and an EBIT margin of more than 7%. For free cash flow, we expect at least EUR 400 million over three years.
Just to give you a sense how we expect that margin increase to happen, as you can see on that slide, on the left side, that's basically what we have already achieved, right? We moved from 2% in the past three years ago in terms of margin to 6% by now, in the last fiscal year. Going forward, the margin improvement will come from basically three buckets. Firstly, we still have a couple of what we call legacy contracts, especially in the submarine division. Those legacy contracts are basically, they come from times when the overall market was not as favorable as it is now. Those contracts are basically, you can say, zero margin contracts, but they will fade out over time and therefore creating a positive mix effect for the overall group margin.
Secondly, the second bucket for the margin improvement is basically our Atlas business. I already mentioned that Atlas has the highest margin, but at the same time also the highest growth rate in our business. This naturally creates another positive mix effect over time for the margin. Thirdly, obviously, as we grow and as we ramp up capacities, this will create some financial leverage and efficiency gains, which will also contribute to the margin improvements over time. This already brings me to my last slide. This slide is also a very important slide for us because it shows just how the mix within our backlog of new versus legacy contracts is changing over time, which is the first bucket that I mentioned in terms of margin improvement.
As you can see, the mix effect or the decline of legacy contracts in our order backlog is already significantly decreasing this year. Less zero-margin contracts in our order backlog, and the order backlog will basically completely cleared from those legacy contracts by the end of the decade with an according positive effect on the Group margin. This basically concludes my presentation. Happy to take the questions now.
Thank you, Johannes. It's very good leaving us some time for questions. We already have a few.
Sure.
Let's start with two considering the pipeline.
Mm-hmm.
I'm going to show them to everybody. Which pipeline projects abroad, Canada, Australia, India, are most promising, and when do you expect firm orders? Probably in the same context, which are the biggest potential orders not yet reflected in the backlog that you have high conviction to be converted into sales in the medium term?
Yeah. Sure. Thanks for the question. I guess that slide that I showed you as part of my presentation is handy to answer the question. As I said, in India, there's no competitor left, so it's only us bidding for that contract, and the same goes for the F127 for Germany. I would say those two contracts, again, it's rather a question when than not if we get the contract. Time-wise, always difficult to say because we are dealing with politicians, and this is always sometimes not very transparent. We hope India still this year, and the German contract, hopefully end of this year, beginning of next year. Again, this is just a guesstimate from our side. In terms of Canada, as I already mentioned, there is still one competitor, the Hanwha Group of South Korea. It's still officially 50/50 for that contract.
We are confident given that we are selling to another NATO country. Our product, I think, is a good one. We are still confident that we have good chances to win that contract as well. For Canada, time-wise, I would say, it's still a little bit further out because here again, we still have a competitor, so the next step would be to be named the sole bidder. Yeah. Afterwards, there will be the final signature. There are still two steps to go. While for India and Germany, it's only one step to go. Yeah. I hope that answers the question.
Yes, I think so. Maybe just to add to that, considering you already have a strong order backlog, when would those additional contracts convert into revenue? Would that be in the medium term or long term?
Yeah, that's a very good question. Thanks for this, because I haven't mentioned that so far in the presentation. The key thing to understand in our business is that we are accounting for those projects with the percentage of completion method. Yeah. That means that we are recognizing revenues in line with the costs that we have as we move through the project life. As you can imagine, a submarine, basically it takes around seven years to build a submarine. In the first year, you only have little cost because you are still at the design phase where the construction has not yet started. As you have little costs, you can also only recognize relatively little revenues. That's just an accounting thing. As the production ramps up and the more costs are being accounted for, we can also account for more revenues.
It's like an S curve. At the beginning, there's a muted development in terms of revenues, and then it ramps up over time as the construction ramps up, and then we can also show the highest revenue growth. Yeah. Also the highest EBIT numbers in our accounts. That's very important to understand. It's always a bit back-end loaded in our business. That's just the nature of the business and the way how accounting works. For those contracts, at day one, when you sign the contract, little revenues because you have little costs, and then over the life of the project, it ramps up. However, what you do have right at the beginning is the cash coming in. Because the cash is basically driven by prepayments, and the prepayments are starting from day one.
At the day when we have the signature, we get the first prepayment, which can be up to 10% of the overall project value. Yeah. The cash comes first, but then P&L-wise, it comes a bit later.
Would you have the capacity to immediately start working on these projects once you win them?
Yes. Yeah, we do have. We are ramping up capacities right now. We ramped up our capacities in Kiel in the past. We are currently ramping up our second shipyard in Wismar, which will start production this year and next year. Wismar, by the way, is a shipyard which can produce submarines and surface vessels, so it's a hybrid yard. We have always the possibility to partner up with third-party yards. Especially in the surface vessel segment, this is quite common that you do not produce the ship in your own yard, but you partner up with partner yards. For example, the MEKO A-200s where we already have signed a preliminary contract with the German Navy. This will be produced not at our yard, but at a partner yard. While the F127, the big A-400 frigate, this one will be produced at our site.
We have enough flexibility in terms of capacity because of partners, but also because of our own ramp-up, to start immediately once we get the contracts.
Okay. That was very clear. Thank you. We have two questions regarding costs. The first one is, how do you ensure cost discipline with such mega projects spanning over multi-year time horizon amid rising raw material input costs? Related to that, do the contracts include inflation adjustment clauses?
Also, very important question, thanks for this as well because that's a key thing that has changed in our new contracts. Remember I mentioned that we still have some legacy contracts, which come from times when the market was not as favorable as it is right now. At that time, we were not able to include inflation clauses and index clauses in our contracts. At that time, cost inflation, steel prices, labor costs, whatever, the risk was on our side. This has changed with our new contracts. In our new contracts, we do have index clauses, which means that we can pass on higher steel prices, and we can pass on higher labor costs, which is really key for us to make sure that we hit our margin targets. In this regard, the cost inflation or the cost risk is not on our side.
At the same time, obviously, we have highly efficient shipyards by now. We have invested EUR 200 million in Kiel for our shipyard there to make it more efficient. Wismar, which I already mentioned, will also be highly efficient, modern shipyard. This also adds to the cost management. Again, the key is that in our new contracts, we have those index clauses. Very important.
Very good. Maybe also relating to that, let's talk about margins.
Mm-hmm.
There's a question. Do you think that margin expansion timing is consistent with the market's fairly aggressive medium-term margin expectations of larger than 8%? Maybe also related to that, Rheinmetall seems to be expecting a high margin in the naval segment and probably compared to you. Why are their margins so high, or why are yours lower, I guess?
Yeah. Thanks for that one. That's a quite common question that we get. First of all, we are guiding for more than 7%, and we always stress that it's more than 7%. We don't think that at 7% the journey will end. We expect margins to further increase once we have hit the 7%. Now, the comparison to Rheinmetall, it's a little bit tricky, I would say. Because Rheinmetall, they acquired NVL. NVL is a naval company which is firstly only producing surface vessels. As I mentioned in my presentation, it's the submarine segment that is currently dragging down our margin. Yeah. They do not produce submarines, so that's one. If I make a pro forma calculation and exclude our submarine segment from our business, our margin would already be at 9%. Already closer to what NVL says.
I would also say that Rheinmetall is conglomerate, a big conglomerate. As a conglomerate, I think you are a little bit more flexible in shifting costs between segments. If you want to make one specific segment, in this case, the naval segment, look a bit better, then you have some flexibility, which is flexibility we do not have. I can imagine that Rheinmetall has some incentive to make the naval business look more favorable because it's an acquisition that they have recently pushed through, and it's a margin dilutive acquisition for them. I guess they have some incentive to show to investors that it's not as dilutive as they might think. Those are just some thoughts from my side. Yeah, I hope that answers that question.
Very interesting. Thank you. A very specific question here on one of your products. What is the schedule for the completion of the German 212CD submarines, and what will be impacts on group cash flow?
The 212CD or the 212.
I think it said.
Submarine?
I think it says 212CF here, but could be a typo.
Yeah, I guess it's a typo. Yeah, the 212CD. That's the one that's, as I said, the most advanced product that we are selling currently to Germany and Norway, and again, hopefully also to Canada in the future. It's already being produced, so it's already, to some extent, in our accounts, in our revenues, and it's definitely already in our cash flow. As I said, cash flow always comes first. It's not very significant yet because remember the S curve, right? We are at the beginning of that project, and at the beginning of the project, the revenue recognition is still a bit muted. Again, it's just an accounting thing. Clearly, this will be a key contributor to our revenue growth in the years to come. Remember, again, submarines are long-term projects. It takes five to seven years to produce them.
The last delivery of those submarines is in 2034, yeah, a long time that we will realize revenue growth over the years.
Very good. There are two questions concerning Atlas. So the first one is, could you explain which are the customers of Atlas Elektronik and its business model, and which products do you expect to be the main revenues drivers within Atlas Elektronik segment over the medium to long term?
Yeah. Atlas has a lot of customers, yeah? They are selling, first of all, 30% of their business goes into our products. 30% of the revenue goes into our submarines and our frigates, yeah, so the combat systems, the sonar systems. 70% of their revenue is third-party revenue, not going into our products. They have customers worldwide. For example, they also have the U.S. as a customer. The other two segments, submarines and frigates, obviously, we're not selling it to the U.S. The U.S. has its own industry in terms of submarines and surface vessels. Atlas Elektronik, they do sell to the U.S., yeah. For example, they also sell to the Ukraine, as I said, some mine hunting systems going to the Ukraine.
I think in terms of revenue growth potential, I would say that those unmanned systems, those underwater drones, those are probably the ones that are the highest growth potential right now. Because as I already mentioned before, I think the key bottleneck for the navies is manpower, and therefore unmanned vehicles are in high demand, yeah. Overall, all the products of Atlas have significant growth potential. Again, Atlas is a very important segment for us, growing strongly, but at the same time, with the highest margins. Obviously, that's a good mix effect.
Very good. We have time for one last question. The question is Fincantieri the right peer for TKMS, or are there important structural differences investors should keep in mind? I don't know whether you can answer that because it also concerns another company, but if you want to comment.
Yeah. It's a peer that I guess many analysts and investors take as a peer for us. There are always differences, yeah. I'm not sure if Fincantieri is as exposed as we are to the electronics business, which is Atlas in our case. Also remember, Fincantieri, so far, they are selling submarines, but the submarines that they are selling basically come from us. Yeah, they are selling submarines based on our license. They have no owned submarine program at the moment. I understand that they want to expand that in the future, but so far, it's basically our submarines that they are selling, yeah.
Understood. Very good. It's half past, so we should wrap it up. Just a comment from my side. Next week, we will have the Austrian Select Conference, so there is a link in the chat box if you want to register for that. We're now going to have a short break. We will continue at 1:30 P.M. with SÜSS MicroTec, also very interesting company. The login link for that event is also in the chat box. With that, it only remains for me to say thank you, Mr. Braun, for very interesting insights you provided. I would like to hand it over to you for some closing remarks, if you want to.
Yeah, of course. Thanks, everybody, for attending. I hope it was useful for you. Any further questions, please let us know. We are always available. Yeah.
Thank you, Mr. Braun.
You too.