Kratos Defense & Security Solutions: The Future of Defense at Price (NASDAQ:KTOS)

The sad reality of the present is that, geopolitically speaking, we live in difficult times. Therefore, countries have no choice but to strengthen their respective armies. This ultimately creates opportunities for defense companies. One of the smaller, but no less interesting names in this segment is Kratos. Defense Security Solutions Co., Ltd.NASDAQ:KTOS). Kratos is a relatively niche player focused on unmanned solutions, military communications, and electronic training systems. These product categories are likely to continue to grow in relevance in the future. As a result, Kratos profits.

Strong growth and healthy balance sheet

Kratos is experiencing strong growth. First quarter revenue increased 19.6% year over year to $277.2 million. In particular, the Unmanned Systems business was the driving force behind revenue growth (+21.8% YoY), but the larger Government Solutions segment still recorded impressive growth. 18.5%. Full-year guidance calls for 2024 revenue between $1,125 and $1,150 million (2023: 1.037 billion dollars).

Kratos’ balance sheet is also quite healthy. Cash and equivalents of $338.9 million provide more liquidity than current liabilities of $288.2 million. Long-term debt is also somewhat moderate at $179.4 million, down nearly $40 million from the previous year. With quarterly adjusted EBITDA of $26 million (fiscal 2023: $95.4 million), this appears entirely manageable. Even more positively, the company continues to generate net income (Q1 net income: $1.3 million).

Potential Buying Target

Another benefit of Kratos from an investment perspective is that it could be a potential acquisition target by a larger competitor. I base my reasoning on two main factors. First, it is relatively small in absolute terms, with a market capitalization of just under $3 billion. It also operates in a space that is expected to see significant growth in the coming years and decades. Obviously, due to the nature of Kratos’ business, the scope of acceptable acquisitions is rather narrow. However, I believe there are still enough names to be interested in an acquisition. Access to the company’s know-how and technology may justify an additional premium to the stock price.

evaluation

Personally, I don’t think an annual profit of around $50 million in a few years is unrealistic. Especially once the XQ-58 is released. valkyrie Combat drones evolve into marketable products or product lines. However, at current market prices, the company is trading at a forward earnings multiple close to 60 based on the above assumptions. Earnings multiples of 20 or slightly lower are common in the defense sector. In my opinion, Kratos deserves some premium due to its above-average balance sheet, strong growth, and potential for future acquisitions. But without a catalyst, you won’t see much of an immediate boost.

danger

It is important to note that relatively high valuations inherently come with downside risk. Given the downside catalysts, there is significant room for downside. Additionally, as a defense contractor, Kratos is intended for a fairly limited audience. After all, the U.S. government is existentially important as both a customer and the sole arbiter of who can buy anything other than the single product the company offers. Moreover, the nature of Kratos’ business makes him a logical target for state-sponsored cyberattacks. If such an attack were successful, the consequences could be severe.

conclusion

Kratos is definitely an interesting name worth keeping an eye on. Its product portfolio is highly relevant to modern defense requirements and has built a technological moat that cannot be easily conquered. The balance sheet is also one of the healthiest in the industry. However, the stock currently appears to be fairly valued, if not somewhat expensive. Therefore, we rate it as a hold for the time being. However, I would caution that catalysts such as falling prices or acquisition interest could change that view in the future.