Critical Pivot To Mission IT And Share Buybacks Will Drive Growth And Boost Net Margins

Key Takeaways

• Shifting towards fixed-price and mission IT contracts is likely to enhance net margins and sustain robust earnings in varied markets.
  
• Significant share repurchase plan could reduce share count and potentially boost earnings per share by increasing stock value.
  
• Transition to fixed-price contracts and government budget pressures pose risks, with uncertainty in large-scale opportunities and revenue growth constraints due to bid conversion challenges.

Catalysts

Provides technical, engineering, and enterprise information technology (IT) services primarily in the United States.

• The company is increasing its bid submissions significantly, from $22 billion to over $25 billion this year, with expectations to reach over $30 billion by fiscal 2027. This increase in bid submissions is expected to drive future revenue growth as these bids convert into contracts and revenue.
  
• A strategic shift towards more fixed-price contracts and mission IT work, which traditionally have higher margins, compared to the current cost-plus contracts, is expected to improve overall net margins.
  
• A new $1.2 billion share repurchase authorization aims to significantly reduce the share count, potentially leading to an increase in earnings per share (EPS) as fewer shares remain outstanding.
  
• The company's focus on enterprise and mission IT, known for their higher-margin profiles, is likely to improve net margins as these areas become a greater portion of revenue, especially with the expected demand for technology solutions that drive efficiency.
  
• Implementing an enterprise operating model with a highly variable cost structure allows the company to adapt its costs quickly to changes in the revenue environment. This adaptability is expected to sustain durable earnings and cash flow even in different market conditions.

Science Applications International Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Science Applications International's revenue will grow by 2.1% annually over the next 3 years.
• Analysts assume that profit margins will increase from 4.1% today to 4.8% in 3 years time.
• Analysts expect earnings to reach $380.7 million (and earnings per share of $8.92) by about December 2027, up from $303.0 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 18.5x on those 2027 earnings, which is the same as it is today today. This future PE is lower than the current PE for the US Professional Services industry at 25.0x.
• Analysts expect the number of shares outstanding to decline by 4.44% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 7.01%, as per the Simply Wall St company report.

Science Applications International Future Earnings Per Share Growth

Risks

• The emphasis on transitioning from cost-plus to fixed-price contracts poses execution risk, as cost-plus work still represents a large portion of SAIC's portfolio. If the transition is not managed well, it could impact net margins.
  
• The integration and timely execution on large-scale opportunities, like the Evolve and S3I recompetes, have inherent uncertainties that could delay or affect revenue realization if not won or successfully renewed.
  
• The potential headwinds from government budgetary pressures and a renewed focus on efficiency, driven by an incoming administration, could affect contracts and constrain revenue growth in some segments.
  
• The company highlights an increased volume of bid submissions, but actual capture rates and conversion into revenue depend on winning these bids and the timing of associated government procurement processes, which can be uncertain and affect projected revenue growth.
  
• The current book-to-bill ratio of 0.9 suggests potential pressure on future revenue growth if not managed towards the target of 1.2, with any delay in achieving this target posing risk to future revenue forecasts.

Valuation

• The analysts have a consensus price target of $137.11 for Science Applications International 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 $155.0, and the most bearish reporting a price target of just $103.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $7.9 billion, earnings will come to $380.7 million, and it would be trading on a PE ratio of 18.5x, assuming you use a discount rate of 7.0%.
• Given the current share price of $114.38, the analyst's price target of $137.11 is 16.6% 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.