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Introduction
Leidos Holdings (NYSE:LDOS), with over 5 a long time of existence, is a Fortune 500 entity that has been leveraging its experience in a number of disciplines, starting from science, tech, engineering, and so forth. to ship mission-critical providers for industries which can be closely regulated (protection, well being, and so forth.). Evidently, given the inherently delicate nature of the work concerned in these industries, getting your foot within the door as a service supplier, after which persevering with to develop your backlog from these avenues, requires a heightened diploma of experience (LDOS’s backlog, which covers anticipated income from negotiated contracts is at present rising at 4%, and stands at $36.6bn.
Over time, LDOS has managed to construct a pleasant repute for servicing the US authorities (the Division of Protection takes priority), both as a contractor or a sub-contractor, with 87% of its income coming from there. LDOS seems effectively poised to be a really perfect recipient of the US authorities’s ongoing generosity with protection spending, which alone at present accounts for 40% of complete world protection expenditure.
![Defense spending by nation](https://static.seekingalpha.com/uploads/2024/6/26/9658941-171940588969438.png)
PGPF
There are some options that protection spending may sluggish in an election yr, however research have proven that economies which have historically had important protection industries usually tend to broaden protection spending in an election yr.
![2024 guidance](https://static.seekingalpha.com/uploads/2024/6/26/9658941-1719405890468706.png)
Q1 Presentation
This yr, the LDOS inventory has additionally taken a cue from upwardly revised earnings steerage on varied metrics, and loved a stellar journey to this point; for context, on a YTD foundation, when the important thing proxy of the US fairness market has managed solely returns of over 15%, our focus inventory has delivered extra returns to the tune of two.45x!
![YTD returns](https://static.seekingalpha.com/uploads/2024/6/26/9658941-17194058912958283.png)
YCharts
To date so good, however we might select to not get too carried away at this juncture, and would moderately charge the inventory as a HOLD
Why LDOS Inventory Might Not Be A Good Purchase Now
Key Divisions To Gradual
LDOS’s second-largest division- Well being and Civil (which accounts for 30% of group income) has loved a surprisingly resilient Q1, with income up by 19%, and working earnings margins increasing by over 700bps! That is primarily on account of upper medical examination volumes however it seems like will probably be extra H1 weighted, with H2 anticipated to be a lot softer as LDOS will possible hit its contracted ceiling worth for the Veterans Administration contract a lot earlier, and can now should rebid once more. In administration’s personal phrases the efficiency of the Well being and Civil phase is predicted to “reasonable within the again half of the yr by means of the aggressive course of”.
Moreover Well being and Civil, additionally be aware that two different segments- Industrial & Worldwide, and Protection Methods, which collectively contribute near 1 / 4 of complete income, noticed income development in Q1 “that was extra sturdy than anticipated”. For context, the latter grew at 7%, and the previous grew at 4%, but each these divisions are solely anticipated to ship flattish development for the FY, so clearly momentum will possible come off within the upcoming durations.
EBITDA Margins Doubtless To Have Peaked, While EV/EBITDA Valuations Look Dear
The opposite factor to notice is that despite the fact that LDOS delivered document EBITDA margins of 12.3% (virtually 300bps of enchancment) in Q1, this isn’t anticipated to be sustained with FY EBITDA margins anticipated to come back in round 800bps decrease at round 11.5%. A lot of this might be pushed by the aggressive rebids that the Well being & Civil division should deal with. Consensus expectations for the subsequent two years additionally counsel that margins may proceed to drop by 15bps in FY25 and one other 13bps in FY26.
![EBITDA margin outlook](https://static.seekingalpha.com/uploads/2024/6/26/9658941-17194058922162097.png)
YCharts
With the margin outlook not as resilient, traders might need to suppose twice about shedding out a premium ahead EV/EBITDA a number of of 12.94x, which interprets to a 12% premium over the inventory’s long-term common.
![EV/EBITDA](https://static.seekingalpha.com/uploads/2024/6/26/9658941-17194058929589467.png)
YCharts
The Dividend Sub-Plot Appears Unappealing
Then, Leidos has been paying quarterly dividends for effectively over a decade now, however one should marvel if getting in now would supply essentially the most appetizing yield. On the present quarterly DPS of $0.38 per share, the present yield solely works out to just a little over 1%, round 40bps decrease than what the inventory has usually yielded over the previous 5 years.
![Dividend yield](https://static.seekingalpha.com/uploads/2024/6/26/9658941-171940588656193.png)
YCharts
Now, LDOS usually raises its dividends in increments of $0.02, and even when they increase it to $0.40 per share, the possible yield would nonetheless quantity to lower than 1.1% at present costs, which isn’t an amazing pitch for earnings traders.
Now whether or not they increase the dividend by $0.02 any time quickly, can even largely depend upon how free money move picks up over time. It’s additionally price noting that LDOS isn’t a type of entities that constantly raises its quarterly dividends yearly. In reality, the latest hike to $0.38 per share solely got here after LDOS had maintained the dividend for 9 straight quarters (which is greater than two years)!
Increased CAPEX Commitments May Weigh on FCF
Coming again to the money move, it was encouraging to see administration elevate their working money move steerage for the yr by $0.2m versus the earlier steerage, however traders additionally want to acknowledge that CAPEX commitments in Q1 obtained off to a really sluggish begin, coming in at 5-year lows of simply $17m.
![CAPEX per quarter](https://static.seekingalpha.com/uploads/2024/6/26/9658941-17194058874139483.png)
YCharts
Administration has implied that this isn’t sustainable, and investments linked to their San Diego facility (amongst different initiatives), may see the quarterly CAPEX runrate development up nearer to the $55-$60m mark. General the intention is to spend round $190m of CAPEX for the yr, so that will find yourself maintaining a lid on important free money move momentum by means of the yr.
Closing Ideas- Value Motion Appears Overextended
Lastly, it’s additionally price noting that the present value ranges of the LDOS inventory look fairly stretched.
![Monthly chart](https://static.seekingalpha.com/uploads/2024/6/26/9658941-17194058881455553.png)
Investing
The picture above captures LDOS’s value actions on a month-to-month foundation, and from 2020 till 2023 it seemed just like the inventory was going nowhere, caught inside a sure vary (space highlighted in yellow). We lastly noticed this vary give method in February with the inventory breaking out fairly strongly; momentum has since continued, however proper now one might start to query if issues are trying stretched. As issues stand, the value is now buying and selling above its higher Bollinger band, which is 2 normal deviations away from the 20-period shifting common! In the meantime additionally be aware that the month-to-month RSI indicator has hit overbought ranges for the primary time since 2020 from the place the value had seen a pointy reversal.
Then, LDOS can also be certainly one of 60 odd shares that comprise the Kensho Future Safety portfolio, which focuses on entities which can be concerned in the way forward for warfare and a nation’s safety. Cut price hunters who give attention to this universe might have favored to have pursued LDOS again in mid-2023 when its relative energy (RS) ratio versus its friends seemed fairly crushed down. Now the scenario is sort of the alternative with the RS ratio buying and selling round 25% larger than its long-term common.
![LDOS:FITE](https://static.seekingalpha.com/uploads/2024/6/26/9658941-1719405888906174.png)
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