New C6ISR Navy Contracts Will Expand Defense Capabilities, Yet Revenue Declines Expected

Key Takeaways

• Expanding C6ISR services for the Navy boosts DLH's defense sector opportunities and revenue potential.
  
• Investments in cybersecurity and R&D enhance growth potential and improve net margins by offering higher-value government services.
  
• High debt levels and revenue challenges from lost contracts could impact DLH's financial flexibility, net margins, and future revenue opportunities in a competitive landscape.

Catalysts

Provides technology-enabled business process outsourcing, program management solutions, and public health research and analytics services in the United States.

• The award of contracts to provide C6ISR and advanced IT services to the Navy represents a significant expansion in DLH's information warfare systems engineering portfolio, driving potential revenue growth through increased opportunities and capabilities in the defense sector.
  
• The company's focus on technology utilization and productivity improvement aligns with current government priorities, suggesting potential positive impacts on future revenue and possibly enhancing net margins through efficiency gains.
  
• The strong pipeline of strategic bids, including several opportunities with contract values exceeding $100 million, could support substantial future revenue growth and offset potential losses from contract erosions due to small business set asides.
  
• Recent investments in cybersecurity, research and development, and systems engineering capabilities are expected to accelerate organic growth and improve net margins by providing higher-value services and solutions to government clients.
  
• The utilization of 50-55% of EBITDA to pay down debt during fiscal 2025, combined with strong cash flow expectations, can lead to reduced interest expenses and improved net margins, positively affecting overall earnings.

DLH Holdings Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming DLH Holdings's revenue will decrease by 19.9% annually over the next 3 years.
• Analysts are not forecasting that DLH Holdings will become profitable in next 3 years. To represent the Analyst Price Target as a Future PE Valuation we will estimate DLH Holdings's profit margin will increase from 1.6% to the average US Professional Services industry of 6.3% in 3 years.
• If DLH Holdings's profit margin were to converge on the industry average, you could expect earnings to reach $12.5 million (and earnings per share of $0.89) by about March 2028, up from $6.4 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 23.2x on those 2028 earnings, up from 10.6x today. This future PE is greater than the current PE for the US Professional Services industry at 21.7x.
• Analysts expect the number of shares outstanding to grow by 1.08% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 11.41%, as per the Simply Wall St company report.

DLH Holdings Future Earnings Per Share Growth

Risks

• The company's revenue decline is impacted by the conversion of certain programs to small business set aside contracts, resulting in reduced revenue streams as they lose these contracts. This could adversely affect future revenues and profits.
  
• The company's high debt levels, currently at $161 million, may limit financial flexibility and lead to increased interest costs, thereby impacting net margins and earnings.
  
• The ongoing ability of DLH to compete and win new large contracts is uncertain, particularly due to small business competitions and the existing competitive landscape, which might negatively affect future revenue opportunities.
  
• Cash flow challenges resulting from collection delays on significant accounts suggest potential future liquidity risks, which could impact operational capabilities and financial stability.
  
• The potential for negative impacts due to a prolonged continuing resolution or changes in government procurement strategies could disrupt existing contracts and new business, impacting future revenues and earnings stability.

Valuation

• The analysts have a consensus price target of $15.0 for DLH Holdings based on their expectations of its future earnings growth, profit margins and other risk factors.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $200.2 million, earnings will come to $12.5 million, and it would be trading on a PE ratio of 23.2x, assuming you use a discount rate of 11.4%.
• Given the current share price of $4.7, the analyst price target of $15.0 is 68.7% higher. Despite analysts expecting the underlying buisness to decline, they seem to believe it's more valuable than what the market thinks.
• 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.