Operational Excellence And Calculated Acquisitions Set The Stage For Stellar Growth And Shareholder Value

Key Takeaways

• Leveraging technological innovations and investments in cybersecurity positions Leidos for revenue growth and margin expansion in high-growth areas.
  
• Strategic acquisitions and focus on high potential areas like hypersonics and satellite payloads suggest significant revenue growth and profitability improvements.
  
• Future revenue and earnings face uncertainty due to reliance on government contracts, fluctuating margins, and risks from international fixed-price contracts and investment in growth without immediate returns.

Catalysts

Provides services and solutions in the defense, intelligence, civil, and health markets in the United States and internationally.

• The focus on operational improvement, profitable growth, and robust cash conversion as part of the Promises Made, Promises Kept culture is improving financial discipline, which can positively impact net margins and earnings.
  
• The commitment to continuing share repurchases as part of capital deployment strategy could support EPS growth, demonstrating a direct effort to enhance shareholder value.
  
• The development and execution of the Leidos North Star strategy, emphasizing technological innovation such as Trusted Mission AI, and investments in cybersecurity like Zero Trust architecture, position the company for revenue growth and margin expansion by staying ahead of future demand and differentiating in high-growth areas.
  
• The strategy to unlock value from significant acquisitions (e.g., Dynetics and security, detection & automation) by focusing on high potential areas like hypersonics and satellite payloads, suggests potential for significant revenue growth and improved profitability in these segments.
  
• Enhanced business capture performance and backlog quality, driven by strategic hires and alignment with strategic direction, indicate potential for revenue acceleration through new business wins and improved operational efficiency, positively impacting net revenues and earnings growth.

Assumptions

• Analysts are assuming Leidos Holdings's revenue will grow by 4.1% annually over the next 3 years.
• Analysts assume that profit margins will increase from 2.7% today to 8.4% in 3 years time.
• Analysts expect earnings to reach $1.5 billion (and earnings per share of $9.34) by about August 2027, up from $436.0 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 17.0x on those 2027 earnings, down from 44.6x today. This future PE is lower than the current PE for the US Professional Services industry at 26.2x.
• Analysts expect the number of shares outstanding to decline by 1.92% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 6.57%, as per the Simply Wall St company report.

Risks

• The company might face uncertainties as it awaits the Request for Proposal (RFP) from the Veterans Benefits Administration (VBA) for disability exam business, impacting future revenue and earnings due to potential changes in contract terms or margins.
  
• Leidos noted higher profitability in Health and Civil segments due to unusual factors like catching up on incentive fee awards, suggesting that such high margins might not be sustainable and could impact future profitability.
  
• The write-downs in the U.K. business on fixed-price contracts due to changing requirements and schedule slippages indicate risks associated with international fixed-price contracts that could affect net margins.
  
• The statement on investment in an innovation fund suggests increased expenses on growth initiatives that may not immediately contribute to revenue, potentially impacting short-term net income.
  
• The company's commentary on the need for an extension of the current VBA contract hints at potential delays in revenue recognition and could place pressure on cash flow and revenue projections if expected new contracts are delayed or terms are less favorable.

Valuation

• The analysts have a consensus price target of $168.3 for Leidos Holdings 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 $190.0, and the most bearish reporting a price target of just $145.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $18.0 billion, earnings will come to $1.5 billion, and it would be trading on a PE ratio of 17.0x, assuming you use a discount rate of 6.6%.
  
• Given the current share price of $144.38, the analyst's price target of $168.3 is 14.2% 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.