Monday, 18 November 2024
by BD Banks
Kratos Defense & Security Solutions (NASDAQ: KTOS) investors are about 15% richer today than they were one week ago. That’s how much this stock has risen since “beating earnings” in its Q3 report last Thursday.
Thursday’s news was just the latest good news from this military drones specialist. The fact is, Kratos beat analyst earnings targets (by double and even triple-digit margins) in each of its past four earnings reports. After three straight years of losing money, Kratos has at last put together one full year of profits, and investors have rewarded Kratos with a 50% gain in share price over the past year.
The question for investors now is: Is Kratos stock unstoppable? Or is its run about to be done? To find out the answer, let’s start with the numbers.
At first glance, Kratos’s Q3 2024 numbers were not particularly impressive. $275.9 million in quarterly sales increased just 0.5% over last year’s Q3. A book-to-bill ratio of precisely 1.0, moreover, suggests revenue won’t grow much in the near future either. (That book-to-bill ratio was also down a bit from Kratos’s performance over the past 12 months).
Earnings for the quarter were positive $0.02, which was better than the $0.01 per share the company lost a year ago. Still, it’s only two cents — not a lot of profit to support a stock that costs more than $25 a share!
And yet, Kratos stock is up 15% on this less-than-overwhelmingly great news. Why is that?
Anemic sales growth and weak earnings notwithstanding, the fact that Kratos has put together back to back (to back, to back) profitable quarters is encouraging in and of itself. Analysts polled by S&P Global Market Intelligence predict that Kratos’s profits — expected to reach $0.12 by the end of 2024 — will triple over the next three years, hitting $0.37 in 2027.
Granted, this still values the stock at 66.5 times earnings (that the company might or might not actually earn) three years in the future, which seems awfully expensive. However, it’s not as expensive as negative earnings, which would give the stock a forward P/E ratio of infinity.
Moreover, Kratos added “color” to its earnings report that investors may find even more encouraging. Historically, Kratos has been known for manufacturing a few key products — aerial target drones (i.e., drones that other people shoot at), more recently expanded to include combat drones (i.e., drones that shoot back), and various communications packages, primarily for satellites.
Over the last couple of years, though, Kratos has expanded its product portfolio, most notably in the field of rocket motors. This product has been greatly in demand lately as defense companies struggle to keep up with the global demand for rockets for missile defense. Kratos also uses these products internally in the production of its target drones and combat drones.
On this subject, Kratos noted that it already has the capacity to produce about 10,000 small jet engines annually for use in drones and missiles. The company also noted that it is continuing work with its partner Aerojet Rocketdyne (now owned by L3Harris (NYSE: LHX)) on Zeus 1 and Zeus 2 solid rocket motor systems for use in hypersonic missiles and ballistic missile tests. The company intends to use Zeus to power its new Erinyes hypersonic missile and “highly classified … Dark Fury hypersonic system” as well.
Finally, on the subject of drones, Kratos already manufactures about 165 jet drones annually, and that capacity is growing to 400 annually. Drone production will include the Kratos Valkyrie combat drone, for which the company expects to win Pentagon production contracts. The company also has one contract for its Athena drone program and hopes to win one for its Apollo drones.
Long story short, Kratos has multiple levers to pull to accelerate its sales growth and lengthen its string of profitable quarters. All this being said, the company remains free cash flow-negative, forecasting anywhere from $10 million to $30 million in cash burn this year. And sales growth next year, while probably better than this year, is still forecast at only about 10%.
At a current-year valuation of more than 200 times earnings, I cannot recommend Kratos stock at today’s share price.
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Rich Smith has no position in any of the stocks mentioned. The Motley Fool recommends L3Harris Technologies. The Motley Fool has a disclosure policy.