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A Military Contractor That’s Surviving Sequestration

By Greg Pugh on October 28, 2013

Most analysts on Wall Street see continued pressure on US defense budgets, as politicians seek to rein in the large federal deficit. With the recent US government shut down, debt ceiling debate and sequestration, most investors remain cautious as to the fundamental outlook for defense companies.

However, there is still life in the defense industry. In particular, this small-cap value company is inking new military contracts that will grow revenues throughout the coming year.

Kratos Defense & Security Solutions
(NASDAQ: KTOS) has been awarded over $38.6 million in new defense orders since the beginning of October 2013. Following revenue growth above 20 percent over the past year, this defense contractor is projected to grow revenues 266 percent in the coming year. This provides an opportunity of 50 percent upside for this undervalued small-cap stock.

Kratos provides outsourced engineering, IT and warfighter solutions primarily to US government, state and local agencies, and to commercial customers. The US military has selected Kratos for numerous defense contract awards in the past month:

  • On October 21, the company received orders valued at $13.7 million for the production of Integrated Microwave Assemblies for two critical US Navy platforms. These awards, from a follow-on customer, are related to continuing production on long-term Electronic Attack and Intelligence, Surveillance and Reconnaissance airborne platforms.
  • On October 15, the company’s SAT Corporation (SAT) subsidiary was selected by Inmarsat to provide SAT’s carrier monitoring and interference detection system, Monics. Monics is the enterprise-networked spectrum measurement and interference analysis system used by 90 percent of the world’s top satellite operators and telecommunications providers in over 57 countries around the world.
  • On October 14, the company’s Defense & Rocket Support Services division received a $2 million research and technology development contract award from the US Army Program Executive Office for Simulation, Training, and Instrumentation. This award is under the Army’s Broad Agency Announcement High Speed Systems Test Science & Technology Test Technology Area.
  • On October 8, the company’s Modular Systems (MS) Division received a $5.6 million order in support of a US Department of Defense/National Security related program, for equipment that will be manufactured by Kratos’ MS Division in a secure Kratos manufacturing facility.
  • On October 7, the company’s MS Division received approximately $8.8 million in orders for specialized products in support of a National Security related program.
  • On October 1, the company received from Sikorsky Aircraft a contract award valued at over $8.5 million to design and develop maintenance training systems for the CH-53K heavy lift replacement helicopter. Kratos will provide a full-fidelity Maintenance Training Device Suite, as well as a Helicopter Emulation Maintenance Trainer, which will be delivered to the Marine Corps Air Station New River, NC.
In the second quarter of 2013, Kratos’ Public Safety and Security division continued to generate strong organic growth, which is expected to continue into the second half of this year, as this business’ backlog and bid proposal pipeline remain near record levels.

Backlog at quarter end was $1.1 billion, with $558 million funded. Backlog at the end of the first quarter was $1.2 billion.

Second-quarter revenue of $235.2 million came in at the high end of the company’s expected range of $230 million to $235 million, due in part to stronger demand for the company’s Public Safety and Satellite Communications businesses.

Second-quarter revenue increased year-over-year 7 percent from $219.8 million, reflecting the organic growth of 17.5 percent in the Public Safety and critical infrastructure business.

Year to date through September, the S&P Aerospace & Defense Index advanced 32.6 percent, versus gains of 22.8 percent for the S&P Industrials Index and 19.2 percent for the S&P 1500 Composite Index. Kratos is up 65 percent (double the Defense Index) during this period and up 23 percent in the past three months.

While the company has forecasted exceptional sales and earnings growth, it trades at only 0.52 times sales in the most recent quarter. Kratos currently has a total market cap of $487 million but has an enterprise valuation of $1.08 billion. This should alert investors to the value proposition of buying this fast-growing stock.

Kratos had a loss of 0.56 per share in 2012 but improved its earnings per share (EPS) to $0.18 in 2013. Kratos is projected to grow earnings by 266 percent, for EPS of $0.66 in 2014.

Kratos Defense & Security Solutions has a 12-month price target of $13, for an increase of 50 percent.

Greg Pugh, an income-investing expert, publishes a newsletter called Investing for Monthly Income.

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