Kratos Defense and Security Solutions Inc (KTOS)

[chmcnfunds]

Kratos: This Below-$6 Drone And Defense Stock Is Undervalued And Poised For Gains

Apr. 23, 2015 8:10 AM ET | About: Kratos Defense & Security Solutions, Inc. (KTOS), Includes: LMT

Disclosure: The author is long KTOS. (More...)

Summary

Geopolitical risks loom large and are a constant reminder that investors should keep defense stocks in mind.
Many larger and well-known defense stocks trade for about 20 times earnings, but some bargains remain in lesser-known small caps.
Kratos continues to win new contracts and its products and services are poised to remain in demand due to the growth in drones, cyber security and other areas.
At just below $6 per share, this stock appears significantly undervalued and it could be poised to continue an upward trend.
Kratos could be "in play" as the company is considering the sale of one or more divisions and as analysts believe this company could be a takeover target.

Kratos Defense & Security Solutions, Inc. (NASDAQ:KTOS) is a relatively unknown defense firm that offers a range of services and products that are very well positioned for future growth. In particular, it appears that the need for drones, lasers, and cyber security will only increase over time and Kratos is poised to benefit since it has developed business in all these key areas and beyond. It has several divisions which include: "Unmanned Systems" which offers aerial target systems, weapons guidance systems, unmanned vehicle control systems, flight termination systems, and radar tracking transponders; "Defense & Rocket Support Services" which provides logistics, engineering, target operations and advanced weapons systems research; "Electronic Products" which offers flight testing and instrumentation for fighter aircraft, ballistic missiles, radar systems, and avionics; "Public Safety & Security" which offers security systems, access control and video surveillance systems; "Modular Systems" which designs and manufactures modular tactical shelters, containers and other equipment for the U.S. Armed Forces, its Allies and other major defense contractors; "Technology & Training" which provides defense simulations, cloud and cyber security solutions, satellite security and command and control solutions. As one Seeking Alpha article points out, Kratos is also poised to benefit from the "imminent rise of the military laser market". Another article from "Optics & Photonics News" shows that Kratos is named as a contractor (as shown below) in some key new laser technologies that are being deployed or developed now.

Laser Weapon System (NASDAQ:LAWS)
U.S. govt. agency: Office of Naval Research
Contractor: Kratos
Description: Solid state; IR commercial off-the-shelf Power: Classified (possibly 15 to 50 kW)
Status: Trial deployment; installation on USS Ponce
scheduled for summer 2014

Solid-State Laser - Technology Maturation
U.S. govt. agency: Office of Naval Research
Contractor: Kratos, Raytheon, Northrop Grumman and BAE Systems
Description: Light tactical-vehicle-mounted
Power: N/A
Status: Design stage

Kratos also recently announced that a rocket motor and payload design it provided for use in an Aegis ballistic missile defense system were successfully tested. See related photo below:

(click link below for photo)

Photo source: Kratos

When you look at this range of offerings, it is clear to see that Kratos has significant growth potential, especially as demand for drones and defense systems against drones appears to be poised for a secular boom in the coming years. Kratos shares have been in an uptrend for the past few months and I believe that this stock can head much higher as more investors get to know this company. I also believe the market is "missing" the big picture potential that Kratos offers and that eventually this company will be given a lot more credit for what it continues to achieve. I almost think of Kratos as a biotech in the sense that it has many emerging technologies and product offerings that have major growth potential. Many smaller tech firms and biotechnology companies post significant losses early on and especially while spending to develop products. Amazingly, Kratos has been able to post profits in some recent quarters, and analysts expect it to earn 55 cents per share in 2016. That implies a forward PE ratio of just about 11 times earnings, which appears very undervalued. By contrast, well-known defense contractors like Lockheed Martin (NYSE:LMT) trades for nearly 20 times earnings. This valuation gap has begun to narrow (as Kratos shares have been trending higher), and I believe it will continue to narrow for a number of reasons. Based on a number of metrics, including the forward PE ratio, market cap, industry growth, annual revenues and the contract backlog this company has, Kratos shares look cheap. I also believe that potential downside risks are limited, especially as this company could be "in play" as either a buyout target or as the company considers the sale of one or more business divisions.

(click to enlarge) (click link below for photo)

As the chart above shows, Kratos shares have been in an uptrend for the past few months. I see this uptrend continuing because this stock appears to be significantly undervalued and also because I believe that positive news flow (such as more contract wins, the sale of business divisions, or the sale of the entire company) can fuel more gains. It also looks like this stock could be poised for a breakout move based on the chart. The 50-day moving average (as indicated by the blue uptrend line) is $5.68 per share, and the 200-day moving average (as indicated by the red line) is $6.12 per share. Based on the current uptrend, it appears that the 50-day moving average could soon cross over the 200-day moving average, which would then create a bullish chart pattern that is known as a "Golden Cross". A Golden Cross formation could attract a new group of investors and traders into this stock, as well as create a catalyst for a short-covering rally.

Kratos has nearly $35 million in cash and about $664 million in debt. Some investors might view that debt load as a potential downside risk, however, I believe the balance sheet is solid and that the debt load is reasonable when you consider other numbers such as the annual revenues and that this company has a major contract backlog. It has a market cap of about $330 million which I believe is way too low considering that this firm generates nearly $1 billion in annual revenues and that it has a contract backlog of nearly $1 billion. Furthermore, if the company does sell one or more divisions as the board of directors has said it was seeking to do, a sale could significantly increase cash balances and/or lower debt levels. If the entire company is sold, this would also make the debt a non-issue. Kratos has announced it retained an investment banking firm to evaluate strategic alternatives which could lead to the sale of non-core businesses or possibly the entire company. I believe the potential for the sale of part or all of the company will support the share price, even in the event of a market pullback (thereby reducing potential downside risks for investors) and if good news is announced, this could be a major upside catalyst for the stock.

Even before the board of directors at Kratos decided to evaluate the potential sale of one or more divisions, multiple analysts considered this company to be an attractive takeover target for a larger defense company. Last year, a Barron's article suggested that the shares were undervalued and that Kratos Defense could be a takeover target, with the potential for a significant premium likely to be offered in the event of a buyout. Clearly, a deal has not occurred yet, but these things can take time and it could be more likely now that the board of directors has opened up to "strategic alternatives". A number of analyst price targets have ranged from about $9 to $10 per share. Earlier this year Noble Financial reiterated a "buy" rating and set a $9 price target. This suggests potential gains of about 75%, from current levels and with the shares trending higher and yet still looking undervalued the risk/reward ratio is now very compelling.

Here are some key points for Kratos Defense & Security Solutions:

Current share price: $5.75
The 52 week range is $4.21 to $9.08
Annual dividend: n/a
Data is sourced from Yahoo Finance. No guarantees or representations
are made. Hawkinvest is not a registered investment advisor and does
not provide specific investment advice. The information is for
informational purposes only. You should always consult a financial
advisor.
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http://seekingalpha.com/article/3093646-kratos-this-below-6-drone-and-defense-stock-is-undervalued-and-poised-for-gains?auth_param=udil:1ajhobc:ab5026227557e33fee616c5a47c28c95&uprof=46

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