Defense and Security Solutions Kratos, Inc. (NASDAQ: KTOS) is a stock that I believe can be very valuable to investors given its strong fundamentals. The nature of the defense industry ensures that KTOS is susceptible to see increased relevance in the years to come, and its position as a US defense contractor gives it a strong commercial profile as well as financial viability.
Kratos Defense & Security Solutions, Inc. is a mid-sized player among defense stocks. The company is one of many contractors to the US Department of Defense. The Company mainly operates under two divisions, which are Government Solutions and Unmanned Systems. Its far-reaching products include defense and rocket systems, microwave technologies, cyber warfare infrastructure, unmanned aerial systems and many others. Through these extensive offerings, Kratos has several high-profile customers such as the US federal government, as well as the government of other US-allied states, as well as large-scale commercial enterprises.
One of the most fundamental strengths in favor of KTOS is that the company is a licensed contractor for the US federal government. In 2020, the US government spent about $767 billion on defense alone, which was more than the next nine countries combined. As a result, the company holds the US Department of Defense customer base as a validation of its offerings, which is a major achievement in the defense industry.
KTOS is a stock that has seen steady growth over the years and has been able to ride out short-term declines, due to the nature of its customer base, as well as the dynamics of the defense industry. The stock has steadily climbed over 600% in the 10 years from 2011 to 2021, making it a viable option for investors to place their funds in.
In my opinion, the most impressive feature of KTOS’ growth trajectory is its presumed immunity to recent shock waves and global disruptions. The most immediate example is the COVID-19 phenomenon which rocked global industries in March 2020. KTOS thus fell by 50%; however, it rebounded soon after and hit a 15-year high of $32.89 in February 2021.
Similarly, the Russian invasion of Ukraine in March 2022 drove up the price of KTOS, especially as NATO states announced increased defense spending, a move that ultimately revitalized the KTOS. entire industry.
Defense stocks are increasingly seen as solid investment options with high growth prospects. Much of this is due to the changing dynamics of defense, which has been in constant motion since human warfare. For this reason, the most successful companies in the field of defense are often the most innovative, allocating substantial amounts to the research and development costs incurred.
As the cyber realm is increasingly used as a warfare attack tactic, the focus is again on stocks such as KTOS that hold cyber attack defense capabilities. In mid-March 2022, Israel was part of a large-scale cyberattack, which was the largest in the country’s history. The government has stressed that it is facing both an increased frequency and quality of cyberattacks against its networks.
The Russian invasion of Ukraine, which dispelled the idea that the world has moved beyond conventional warfare between sovereign nation-states, has been a game-changer for defense actions in 2022. As a result, countries in the Union have significantly increased their defense spending for the year, preparing the military infrastructure to prevent military attacks, against the growing Russian threat.
KTOS is ready to seize the opportunities of this dynamically evolving field, with its hands-on approach to research and development, with a strategic approach centered on innovation. As shown in the graph below, the company is committed to increasing its research and development costs on a yearly basis.
The current focus of this research spending is on satellite surveillance and communication, unmanned aerial systems, and turbine technologies. As a result, the company depends on its proprietary rights to maintain its commercial sustainability, which it protects through trademarks, patents, confidentiality agreements and trade secret legislation.
This is a fundamental strategy for its business sustainability, to survive in a dynamic and fast-paced industry, which is constantly evolving with advances in many technological fields. Another reason why R&D is such an important focus for the company is due to the rate at which defense systems require upgrading with new technologies, and thus earlier models tend to become obsolete.
The company’s recent full-year 2021 earnings report delighted shareholders, with total revenue of $811.5 million outpacing 2020 sales volume of $747.7 by 8.5%. . According to management statements, this increase was mainly due to sales in the unmanned aerial segment, as well as increased demand for microwave, space and cyber products, due to the changing nature of the industry. defense.
Similarly, the increase in sales had also led to KTOS EPS revenue growth from $0.33 per share in 2020 to $0.36 in 2021. The company’s profitability had exceeded established expectations. by the Zacks Estimate Consensus of an impressive 22.2%. With rising administrative, selling, and development costs, Kratos consistently generates profits at an increasing rate. This denotes an increasing degree of operational efficiency, correlated with business growth, suggesting the achievement of economies of scale.
The upward trend in the company’s sales can be seen as early as 2017, as shown in the graph below:
As can be seen, there is a clear growth momentum that the company has maintained from 2017 to 2021. This highlights the company’s ability to create value and the financial sustainability of its business model. I think that momentum is strong, given the nature of the industry, with governments increasingly looking to build up the country’s defensive and military capabilities.
Focusing solely on stock performance, KTOS appears to have an impressive trajectory over the past five years, particularly against the Russell 2000 Index, as well as a peer group of sizable defense stocks. similar.
Operation assumes a $100 investment as a starting point in comparable stocks, including KTOS, with all dividends reinvested in the particular category of investment. Following this investment decision almost doubles the value of the amount of capital for a $100 investment in the Russell 2000 Index. Similarly, the shares of the peer group have almost tripled in value over the five-year period . Finally, KTOS turns out to be the investment option with the most impressive growth trend over the five years, rising from $100 to nearly $700.
Moving on to the company’s valuation profile, there is a clear indication that KTOS stock is significantly undervalued. Analysts have determined based on cash flow that KTOS holds a fair value of $41.73, from its current price of $16.94, as of April 22, 2022.
Based on this valuation analysis, KTOS is undervalued by almost 60%, which is a clear signal for this stock to be bought with immediate effect.
Additionally, this view is reinforced by taking a look at where KTOS stands against its P/B ratio, as shown in the chart below:
KTOS holds an attractive P/E ratio against the US aerospace and defense industry, which has a calculated value of 2.54. By comparison, Kratos, with its P/E ratio of 2.23, holds a lower premium to its book value, suggesting undervaluation, which investors would be wise to take advantage of.
To optimize your portfolio of KTOS, you need to understand the main risks associated with the stock. The biggest risk is the company’s reliance on its biggest customer, the US government. While this strengthens the stock’s trading position, it adds significant market risk that could potentially impact the sustainability of the business. Because of this reliance on the US government for revenue, a slight shift in fiscal policy or government strategy could potentially hit the company hard. Additionally, there is growing pressure from a range of activists across the United States to cut military spending. Although the likelihood of this risk remains low, Kratos must ensure the diversification of its customers and focus on expanding its market to broader areas.
Additionally, the company’s continued success is highly dependent on the company’s stakeholder management of prime contractors and government defense agencies. Failure to maintain these relationships could result in the loss of crucial contracts in future economic cycles. This risk, however, is significantly counteracted by the hiring of Robert Winkler as Kratos’ new Vice President of Corporate Development and National Security Programs in April 2022. Winkler, who is a former Senate staffer American on the Armed Services, maintains crucial ties with the United States. Department of Defense, as well as the Pentagon. Having also been responsible for the staff of the Air Land Committee, Winkler would be able to add value to the company by trading its low-cost, high-performance technologies.
KTOS is a mid-sized US defense company that has grown steadily over the years and enjoys a strong market position as a certified US defense contractor. The company’s impressive financial progress over the years and its competitive position in the market make it a solid option for investors. I recommend KTOS stock as a buy given the steady growth it has brought which has remained sheltered from global disruptions. Additionally, changing defense dynamics and the crisis in Ukraine have triggered a set of circumstances that could push the stock towards long-term growth.