michael vie
The sad reality of today is that, geopolitically speaking, we live in difficult times. Therefore, each country has no choice but to strengthen its own military. This creates opportunities for defense contractors. One of his smaller but interesting names in this field is Kratos. Defense & Security Solutions Co., Ltd. (Nasdaq:KTOS). Kratos is a relatively niche player focused on unmanned solutions, military communications, and electronic training systems. The relevance of these product categories is likely to continue to grow. As a result, Kratos stands to benefit.
Strong growth and healthy balance sheet
Kratos is showing rapid growth. Q1 Revenues increased 19.6% year over year to $277.2 million. While the unmanned systems business in particular is driving revenue growth (+21.8% year over year), the larger government solutions segment continues to see impressive growth. 18.5 percent. With full-year guidance, 2024 revenue is expected to range from $11.25 million to $1.15 billion (2023: $1.037 billion).
Kratos’ balance sheet is also very healthy. The $338.9 million in cash and equivalents provides sufficient liquidity to outweigh his $288.2 million in current liabilities. Long-term debt was also fairly modest, at $179.4 million, down almost $40 million year over year. Quarterly adjusted EBITDA was $26 million (2023: $95.4 million), which looks completely manageable. What’s even better is that the company consistently generates net income (Q1 net income: $1.3 million).
Potential acquisition target
From an investment perspective, an additional benefit for Kratos is that it could be a potential acquisition target for a larger competitor. I base this reasoning on his two main factors. First, his market capitalization is just under $3 billion, which is relatively small in absolute terms. We also operate in areas that are expected to see significant growth in the coming years and decades. Obviously, due to the nature of Kratos’ business, the range of acceptable acquirers is somewhat narrow. But I believe there are still enough names that could be interested in an acquisition. Access to the company’s know-how and technology probably justifies the additional premium in the stock price.
evaluation
Personally, I think profits of about $50 million per year within a few years are not unrealistic, especially once the XQ-58 is released. valkyrie Combat drones will evolve into a marketable product or product family. However, at current market prices, and based on the above assumptions, the company trades at a forward earnings multiple close to his 60x. In the defense sector, earnings multiples of 20x or slightly below are common. In my opinion, Kratos is worth a certain premium given its above-average balance sheet, strong growth, and potential future acquisition target. But without a catalyst, I don’t see an immediate upside.
danger
It’s important to note that relatively high valuations inherently include downside risk. Considering downside factors, there is room for a significant decline. Also, as a defense contractor, Kratos caters to a fairly limited audience. After all, the U.S. government is the customer and the sole arbiter of who else can buy, but the single product the company offers is critical to its survival. Additionally, the nature of Kratos’ business makes it a logical target for state-sponsored cyberattacks. If such an attack were successful, the impact could be significant.
conclusion
Kratos is certainly an interesting name to keep an eye on. The product portfolio is highly relevant to modern defense requirements, creating a technological moat that is not easily overcome. Its balance sheet is also among the healthy in the industry. However, the current share price looks like a good value, if not a little overvalued. Therefore, for the time being, we are rating it as pending. However, we caution that this view may change in the future due to triggers such as falling prices or acquisition interest.
