On Sunday The Guardian revealed 29-year-old Edward Snowden as the source behind leaks detailing the National Security Agency’s surveillance program. Snowden, a former CIA employee, obtained access to NSA files through his work for consulting firm Booz Allen Hamilton (BAH). The Tysons Corner, Virginia-based firm is one of the government’s top contractors, with The New York Times reporting that 23%, or $1.3 billion, of its fiscal year 2012 revenue came from intelligence work.
Booz Allen’s shares fell by 2.56% on Monday after the revelation of Snowden’s identity, most likely due to concern over the firm’s standing in the wake of the security breach. The fallout of the NSA leak is the latest challenge facing Booz Allen as it deals with the effects of sequestration, including an expected “low single digit decline in revenue”.
While the consulting firm is at the center of the NSA controversy, it is not the only defense contractor worried about the impact of the Snowden leaks on its relationship with the government. However, Republican strategist John Ullyot told Politico that the leaks will most likely affect employee security clearances since defense contractors play an integral role in government operations.
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According to research and consulting firm Barr Group Aerospace, the Department of Defense has awarded $102.2 billion in defense contracts for fiscal year 2013 as of May 1st. Booz Allen has received $381 million in contract awards, making it the year’s 40th top awardee in terms of contract value. Lockheed Martin (LMT) leads the list with $13.7 billion in contract awards, Boeing (BA) comes in second with $7.7 billion, and General Dynamics (GD) rounds out the top three with $5.43 billion.
Of the top 100 defense contractors listed by Barr Group Aerospace, 40 are publicly traded on U.S. exchanges.
Within that group of companies, 10 – including Booz Allen – are undervalued by high ratios of levered free cash flow/enterprise value.
Levered free cash flow is the money that remains after deducting interest payments on outstanding debt, which can then be used to pay for future business operations and expansion. Enterprise value is an alternative to using market capitalization to determine a company's value and is calculated by subtracting total cash and cash equivalents from market capitalization plus debt, minority interest, and preferred shares. When a company's ratio of levered free cash flow/enterprise value ratio exceeds 10%, it may be indicative of undervaluation.
Do you think these defense contractor stocks are truly undervalued? Use this list as a starting point for your own analysis.
1. ManTech International Corporation (MANT, Earnings, Analysts, Financials): Provides technologies and solutions for national security programs in the United States and internationally. Market cap at $1.04B, most recent closing price at $27.89.
Levered free cash flow at $112.10M vs. enterprise value at $1.03B (implies a LFCF/EV ratio at 10.88%).
On June 4th the technology provider announced it had been awarded a contract by the Space and Naval Warfare Systems Center (SSC) Atlantic. With this contract, ManTech will provide “full lifecycle support for command, control, and decision support systems” for global SSC Atlantic customers.
2. CACI International Inc. (CACI, Earnings, Analysts, Financials): Provides information technology (IT) and professional services to the United States federal government and commercial markets internationally. Market cap at $1.49B, most recent closing price at $64.72.
Levered free cash flow at $219.77M vs. enterprise value at $2.11B (implies a LFCF/EV ratio at 10.42%).
Back in April CACI won a $9.7 million contract modification to provide management and engineering support to the Department of Defense’s biometric programs back.
3. Booz Allen Hamilton Inc. (BAH, Earnings, Analysts, Financials): Provides professional services primarily to US government agencies in the defense, security, and civil sectors, as well as to corporations, institutions, and not-for-profit organizations. Market cap at $2.39B, most recent closing price at $17.54.
Levered free cash flow at $452.89M vs. enterprise value at $3.79B (implies a LFCF/EV ratio at 11.95%).
The consulting firm was awarded two contracts in May: a $4.3 million award from Defense/Advanced Research Projects Agency and a $3.7 million award from the Air Force/Space Command.
4. Computer Sciences Corporation (CSC, Earnings, Analysts, Financials): Provides information technology (IT) and professional services to governments and commercial enterprises. Market cap at $6.92B, most recent closing price at $46.07.
Levered free cash flow at $1.03B vs. enterprise value at $7.37B (implies a LFCF/EV ratio at 13.98%).
In February the Coast Guard awarded the company part of an $11 billion contract to provide support services to the Department of Homeland Security. This follows the company’s November contract modification of its simulator-based flight and aviation training device upgrade at the Army Aviation Center of Excellence.
5. Textron Inc. (TXT, Earnings, Analysts, Financials): Operates in the aircraft, defense, automobile, industrial, and finance businesses worldwide. Market cap at $7.48B, most recent closing price at $26.91.
Levered free cash flow at $1.32B vs. enterprise value at $10.53B (implies a LFCF/EV ratio at 12.54%).
Textron subsidiary AAI was awarded a $19.6 million contract to supply Universal Test Sets to the Navy’s Explosive Ordnance Division. Later in the month, the company’s Bell Helicopter division won an $85 million contract for foreign military sales to Iraq and Taiwan.
6. Northrop Grumman Corporation (NOC, Earnings, Analysts, Financials): Provides products, services, and solutions in aerospace, electronics, information systems, shipbuilding, and technical service sectors. Market cap at $19.7B, most recent closing price at $83.75.
Levered free cash flow at $2.16B vs. enterprise value at $20.13B (implies a LFCF/EV ratio at 10.73%).
Yesterday, Northrop Grumman announced that the Navy had awarded the company a contract to support minehunting integration. This follows Northrop Grumman’s late May announcement of its Enterprise Application Development and Integration Support contract from the Defense Intelligence Agency.
7. General Dynamics Corp. (GD, Earnings, Analysts, Financials): Provides business aviation, combat vehicles, weapons systems and munitions, military and commercial shipbuilding, and communications and information technology products and services worldwide. Market cap at $27.75B, most recent closing price at $78.58.
Levered free cash flow at $3.22B vs. enterprise value at $27.29B (implies a LFCF/EV ratio at 11.8%).
General Dynamics received two Navy contracts last week: its Bath Iron Works division won a $2.8 billion shipbuilding contract, and its Advanced Information Systems unit won a $31.5 million to support Advanced Mission Computers in Navy aircrafts.
8. Hewlett-Packard Company (HPQ, Earnings, Analysts, Financials): Offers various products, technologies, software, solutions, and services to individual consumers and small- and medium-sized businesses (SMBs), as well as to the government, health, and education sectors worldwide. Market cap at $47.23B, most recent closing price at $24.49.
Levered free cash flow at $12.02B vs. enterprise value at $60.80B (implies a LFCF/EV ratio at 19.77%).
Last month, the company’s HP Enterprise Services division won a contract with the Navy to help its medical facilities maintain electronic records.
9. MetLife, Inc. (MET, Earnings, Analysts, Financials): Provides insurance, annuities, and employee benefit programs primarily in the United States, Japan, Latin America, the Asia Pacific, Europe, and the Middle East. Market cap at $49.93B, most recent closing price at $45.60.
Levered free cash flow at $15.96B vs. enterprise value at $78.06B (implies a LFCF/EV ratio at 20.45%).
The insurance provider manages the Department of Defense’s TRICARE Dental Program.
10. Express Scripts Inc. (ESRX, Earnings, Analysts, Financials): Provides a range of pharmacy benefit management (PBM) services in North America. Market cap at $51.28B, most recent closing price at $62.73.
Levered free cash flow at $6.69B vs. enterprise value at $63.24B (implies a LFCF/EV ratio at 10.58%).
The pharmacy benefit company is the current contractor for the Department of Defense’s TRICARE Pharmacy Program
(List compiled by Mary-Lynn Cesar)
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