Vertical Integration And Critical Partnerships Propel Aerospace And Defense Leader To New Heights

Key Takeaways

• Focus on internal investment and partnerships, like with General Electric Aerospace, aims to boost future revenue through enhanced production capabilities and efficiency.
  
• Diversifying into unmanned systems, rocket systems, satellite communication, and cybersecurity is positioned to drive substantial growth and profitability.
  
• Exposure to supply chain risks, increased operating costs, and uncertain federal budget impacts could hinder Kratos' growth and financial performance.

Catalysts

Kratos Defense & Security Solutions, Inc.

• Kratos Defense & Security Solutions has been focusing on internally funded investments to rapidly develop, engineer, and market products, systems, and solutions in collaboration with partners and customers, impacting future revenue growth.
  
• The company's strategy of vertical integration, including expanding manufacturing capabilities and establishing new production lines for engines and drones, is expected to enhance operational efficiencies and contribute positively to net margins.
  
• The new partnership with General Electric Aerospace for the production of thousands of low-cost engines for drones and missiles could significantly increase future production capacity and drive revenue growth.
  
• Kratos’ diverse portfolio, particularly in unmanned systems, rocket systems, and satellite communication, along with a strong pipeline in hypersonic vehicles, positions the company for substantial future growth contributors based on customer demand.
  
• Investments in cyber security and the expected future growth in this sector, given the progression of DoD's Cyber Maturity Model Certification program, could be a high-margin business contributing to the overall profitability of the company.

Assumptions

• Analysts are assuming Kratos Defense & Security Solutions's revenue will grow by 9.9% annually over the next 3 years.
• Analysts assume that profit margins will increase from 0.9% today to 4.0% in 3 years time.
• Analysts expect earnings to reach $59.4 million (and earnings per share of $0.39) by about September 2027, up from $9.8 million today. However, there is a considerable amount of disagreement amongst the analysts with the most bullish expecting $72.9 million in earnings, and the most bearish expecting $39.1 million.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 117.4x on those 2027 earnings, down from 325.0x today. This future PE is greater than the current PE for the US Aerospace & Defense industry at 32.8x.
• Analysts expect the number of shares outstanding to grow by 17.91% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 5.95%, as per the Simply Wall St company report.

Risks

• The reliance on certain highly specialized components and a limited number of suppliers for turbofan engine production in collaboration with General Electric Aerospace poses a supply chain risk that could affect the ability to meet demand and timelines, potentially impacting revenue and profitability.
  
• The delay in satellite launches and deployment of commercial satellite ground equipment due to technical challenges faced by manufacturers of software-defined satellites could lead to a downturn in the space and satellite business segment, impacting overall revenue growth.
  
• The necessity to prepay or deposit to secure positions with vendors, as mentioned, indicates potential vulnerability in Kratos' supply chain management. This could lead to increased operating costs and a negative impact on cash flows and net margins.
  
• The company's bid and proposal investment of approximately $2 million for a single opportunity suggests a significant financial commitment to secure new contracts. If these investments do not result in contract awards, it could negatively affect earnings and reduce the funds available for other growth opportunities.
  
• The anticipated impact of potential continuing resolutions in the federal budget and its effect on contract awards and funding increases could lead to delays in program starts and expansions. This uncertainty could result in fluctuating revenue streams and may hinder the expected growth trajectory, particularly in the space and satellite segment and potentially across other defense-related projects, affecting the overall financial performance.

Valuation

• The analysts have a consensus price target of $23.73 for Kratos Defense & Security Solutions 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 $27.0, and the most bearish reporting a price target of just $19.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $1.5 billion, earnings will come to $59.4 million, and it would be trading on a PE ratio of 117.4x, assuming you use a discount rate of 6.0%.
• Given the current share price of $21.09, the analyst's price target of $23.73 is 11.1% higher.
• 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.