US And European Defense Trends Will Drive Transformation

Key Takeaways

• Alignment with global defense modernization and digitization trends is driving higher-margin contracts, improved backlog quality, and greater revenue visibility.
  
• Operational enhancements and R&D investments support margin expansion and a shift toward a more predictable, higher-value earnings model.
  
• Growth and margin prospects are challenged by legacy contract burdens, unrepeatable revenue acceleration tactics, and ongoing execution risks amid dependence on defense sector demand.

Catalysts

A technology company, manufactures and sells components, products, modules, and subsystems for defense prime contractors, the U.S.

• Growth in backlog and bookings across U.S. and European defense primes-particularly in radar, electronic warfare, and sensor modernization-demonstrates strong alignment with defense modernization and increased global defense spending, which is likely to support sustained revenue growth and future EPS expansion as these programs convert to production.
  
• Expanding penetration into programs that require secure, high-performance embedded processing and open-architecture modular solutions positions Mercury to benefit from the defense sector's shift toward greater digitization and AI/ML adoption, supporting higher-margin, higher-value contracts and improved long-term gross and net margins.
  
• Prioritization of domestic sourcing and supply chain re-shoring in sensitive defense technologies creates a competitive advantage for Mercury as a U.S.-based supplier, increasing contract win rates with both prime contractors and government agencies, which should enhance revenue visibility and future backlog quality.
  
• Ongoing operational improvements-including automation, streamlined processes, and working capital reduction-are driving operating leverage, and as low-margin legacy backlog is replaced by new, higher-margin contracts, this is expected to result in sequential margin expansion and improved earnings trajectory.
  
• Investments in R&D and expanded product offerings (including acquisition integration and common processing architectures) are enabling wins in next-generation programs and recurring business, supporting a long-term transition toward a higher-margin, more predictable earnings model.

Mercury Systems Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Mercury Systems's revenue will grow by 6.1% annually over the next 3 years.
• Analysts assume that profit margins will increase from -4.2% today to 4.1% in 3 years time.
• Analysts expect earnings to reach $44.5 million (and earnings per share of $1.09) by about August 2028, up from $-37.9 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $65.8 million in earnings, and the most bearish expecting $11.1 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 110.9x on those 2028 earnings, up from -108.1x today. This future PE is greater than the current PE for the US Aerospace & Defense industry at 32.2x.
• Analysts expect the number of shares outstanding to grow by 0.47% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.94%, as per the Simply Wall St company report.

Mercury Systems Future Earnings Per Share Growth

Risks

• The company's near-term revenue growth is expected to be modest (low-single digits in FY26), impacted by prior acceleration of deliveries and a significant allocation of factory capacity to legacy programs with large unbilled receivables, which generate free cash flow but contribute little incremental revenue-potentially pressuring top-line growth and earnings in the medium term.
  
• While gross and EBITDA margins have improved due to operational initiatives and a better mix in bookings, Mercury is still burdened by a significant backlog of older, low-margin contracts that will continue to be executed through FY26; this may constrain further margin expansion in the near term and slow progress toward target net margin levels.
  
• The company's historical pattern of pulling forward deliveries to accelerate revenue recognition creates future period headwinds, and its reliance on efficiently accelerating customer orders may not be repeatable, especially as outstanding high-margin backlog diminishes-threatening both revenue consistency and operating leverage in future years.
  
• Mercury continues to face execution and integration risks associated with operational streamlining, shifting contract structures (e.g., focus on deferred revenue and unbilled receivables), and transitions out of legacy contract terms; failure to manage these risks or delays in achieving optimal working capital levels could result in higher costs and negatively impact free cash flow and net earnings.
  
• The long-term growth outlook is highly dependent on ongoing robust defense budgets, timely conversion of pipeline opportunities (like those tied to "Golden Dome" and expanded international demand), and the ability to win new design awards; any budgetary pressures, market delays, or inability to translate current customer conversations into confirmed bookings would meaningfully affect future revenue and earnings trajectories.

Valuation

• The analysts have a consensus price target of $65.429 for Mercury Systems based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $80.0, and the most bearish reporting a price target of just $39.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $1.1 billion, earnings will come to $44.5 million, and it would be trading on a PE ratio of 110.9x, assuming you use a discount rate of 7.9%.
  
• Given the current share price of $68.39, the analyst price target of $65.43 is 4.5% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.