Leidos Holdings: Still Appealing Despite Mixed Performance (NYSE:LDOS)

If you want a company that generates a large portion of its revenue from contracts with the US government, particularly a firm that offers services and solutions centered around digital transformation, communications, intelligence, software, analytics, mission support, logistics services, and more, one firm definitely worth considering is Leidos Holdings (NYSE:LDOS). When it comes to this space in particular, I’ve generally been a bit wary from an investment perspective. The nature of the enterprises often leads to shares trading at rather lofty levels. But that has not been the case with this play. In fact, while shares of the company might be slightly near the low end of the scale compared to similar firms, they do look cheap on an absolute basis as well. Recently, financial performance achieved by the firm has been somewhat mixed. But so long as management can hit their targets or come close to it, upside for investors from here should be attractive.

Outperformance continues

The last article I wrote about Leidos was published in early August of 2022. In that article, I talked about how well the company had done leading up to that point, with shares rising in response to revenue growing. Unfortunately, the bullish picture for the company had been dented some because of profitability issues. But given how affordably priced shares were, I felt as though the upside potential was attractive enough for the company to keep the ‘buy’ rating I originally assigned it. Since then, the market has largely agreed with me. Although shares have generated a loss of 1.9%, that’s better than the 5.6% decline experienced by the S&P 500. And from the first article that I wrote about the company in February of 2022, shares are up 6.9% compared to the 8.2% drop the S&P 500 experienced.

The continued outperformance of the company relative to the market has been driven, in my belief, largely by the fact that revenue continues to grow at a nice clip and the fact that shares look attractively priced. On the revenue side, during the third quarter of 2022, the company reported sales of $3.61 billion. That’s 3.6% above the $3.48 billion reported one year earlier. This rise, management said, was largely because of program wins and a net increase in volumes on certain programs. The picture actually would have been better had it not been for the fact that foreign currency fluctuations impacted sales to the tune of $28 million and because of an unspecified amount of net write-downs on certain contracts.

Although sales for the company did increase nicely, profits came under pressure. Net income fell from $205 million to $162 million. This seems to have been related largely to a $15 million increase in non-operating expenses and a decline in the company’s operating income to 7.8% of sales compared to the 8.8% reported one year earlier. The drop in operating income was mostly because of net write-downs, the completion of certain contracts and additional general and administrative costs. Interestingly, operating cash flow moved in the other direction, jumping from $565 million to $748 million. But if we adjust for changes in working capital, it too would have fallen, plunging from $316 million to $195 million. Meanwhile, EBITDA for the business also declined, dropping from $403 million to $372 million.

For the first nine months of 2022 as a whole, sales of $10.70 billion beat out the $10.25 billion reported the same time one year earlier. Even though sales increased, profits once again took a beating, dropping from $579 million to $508 million. Just as was the case with the third quarter alone, operating cash flow managed to increase, climbing from $821 million to $881 million. But on an adjusted basis, it fell from $872 million to $618 million, while EBITDA dropped from $1.15 billion to $1.10 billion.

For 2022 in its entirety, management has provided some guidance. At present, they anticipate sales of between $14.2 billion and $14.4 billion. At the midpoint, this would translate to a 4.1% increase over the $13.74 billion reported one year earlier. Earnings per share of between $6.20 and $6.40 should translate to net income, at the midpoint, of $869.4 million. Management said that operating cash flow should be at least $1 billion, while EBITDA should be somewhere around $1.49 billion. Based on these numbers, the firm is trading at a price-to-earnings multiple of 15. The price to adjusted operating cash flow multiple should be 13.1, while the EV to EBITDA multiple should come in at 11.6. By comparison, if we were to use data from 2021, these multiples would be 17.3, 11.6, and 11.5, respectively. I also, in conducting the research for this article, decided to compare the firm to five similar businesses. On a price-to-earnings basis, these companies ranged from a low of 10.6 to a high of 24.1. Only one of the five firms was cheaper than our target. Using the price to operating cash flow approach, the range was from 12.3 to 58.7. And when it comes to the EV to EBITDA approach, the range would be from 10.4 to 17. In both of these scenarios, only two of the five companies were cheaper than Leidos.

Company	Price / Earnings	Price / Operating Cash Flow	EV / EBITDA
Leidos Holdings	15.0	13.1	11.6
TransUnion (TRU)	10.6	58.7	17.0
Booz Allen Hamilton Holding Corp. (BAH)	23.8	24.8	15.4
Jacobs Solutions (J)	24.1	32.7	14.1
Teleperformance SE (OTCPK:TLPFY)	22.3	12.4	11.2
Intertek Group (OTCPK:IKTSY)	20.5	12.3	10.4

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Takeaway

Although shares of Leidos have taken a slight step back over the past few months, the company continues to outperform the broader market. All things considered, I would say that this particular play has been working out nicely for shareholders since I initially wrote about it. Continued revenue growth suggests that bright days are ahead for the company. But as always, investors should pay attention to how bottom-line results change since, at the end of the day, the bottom line is what determines the value of a firm the most. Considering how attractively priced the shares are though, I would say that the stock still has some upside life to it, to the point that I believe it still makes sense to give it a soft ‘buy’ rating at this time.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.