This Defense Stock Is Breaking Out After $1.45 Billion News
An unmanned aerial contracting specialist is enjoying a surge after revealing details of a five-year OTA contract.
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Long-time readers might recall that one of our first winners, or first winners once Chris Versace and I started running the old "Stocks Under $10" portfolio back in the day, was unmanned aerial contracting specialist Kratos Defense & Security KTOS.
It's so long ago that I don't remember where we entered. We got out with a $17 handle. I remember that, and feeling like we hit a home run, because the stock traded lower for a while after that.
We never really gave KTOS another solid thought as the "drone" space became more crowded and the firm's business at times had struggled. That's unfortunate. Why? Because KTOS has been in an uptrend since late 2022, closed on Friday at $27.48. The stock has been trading higher overnight as well due to some fairly high-profile news.
Monday Morning News!
This morning, in a press release, Kratos revealed that it had been awarded a five-year OTA contract for the multi-service advanced capability hypersonic test bed (MACH-TB) 2.0 under Task Area 1. The total value of the award, if all options are exercised over the life of the contract, would be $1.45 billion.
For those who do not know, the Office of the Under Secretary of Defense for Research and Engineering Test Resource Management Center established MACH-TB to support the OUSD's National Hypersonic Initiative 2.0 by creating an affordable flight test bed to rapidly increase hypersonic flight test capacity.
The idea is to reduce overall hypersonic development risks and time and provide rapid transition of innovative hypersonic technologies to the warfighter. Also, for those who might not know, other transaction agreement (OTA) contracts allow the federal government to develop award terms and conditions based on project objectives and are meant to expedite access to technology. OTAs are not subject to standard procurement regulations, thus cutting back on red tape and ultimately saving the government money over the life of the deal.
The CEO...
Eric DeMarco, president and CEO at Kratos commented in the press release, "Kratos is honored to receive the largest contract award in our company’s history, a testament of the value Kratos’ employees and team bring both to our Company and United States National Security. This programmatic milestone underscores our unwavering commitment to making upfront investments for rapidly developing, and being first to market with affordable, mission-critical solutions that meet the evolving needs of the warfighter. The MACH-TB 2.0 program award is an important element of Kratos’ future year organic growth forecast and expectation.”
Earnings
Kratos reported the company's third quarter financial results in early November, and therefore, will not report the firm's fourth quarter until late February. Currently, Wall Street is looking for an adjusted EPS of $0.10 on revenue of $287.6 million. That would compare to $0.12 for the year-ago period, while reflecting sales growth of 5%. For the full year 2025, Wall Street sees adjusted earnings growth of 25% on revenue growth of more than 11%. While those full-year estimates are impressive this is, of course, prior to the just announced federal award.
Wall Street obviously sniffed something out though, because the stock went out on Friday trading at 42-times forward-looking earnings which is a growth stock valuation and Kratos has not been a growth stock. The stock came in with just about 2% of the float held in short positions, so that's not what we are seeing this morning. Much of the interest on the bid side of KTOS this morning is likely organic.
Balance Sheet
As of the end of the September quarter, Kratos ran with a cash position of $301.5 million, inventories of $158.9 million and current assets of $838.4 million. Current liabilities added up to $260.5 million, with unearned revenues of $61.9 million. At the headline level, that puts the firm's current and quick ratios at 3.22 and 2.61, which is very healthy. Once adjusted for unearned revenue, these ratios improve to an even stronger 4.22 and 3.42, respectively.
Total assets amounted to $1.912 billion including $624.8 million in goodwill and other intangibles. At 32.6% of total assets, this is a lot, but nowhere near being high enough to sound any alarms. Total liabilities less equity came to $569.5 million, including $177 million worth of long-term debt. Kratos obviously has enough cash on hand to take care of this entire debt-load nearly two times over.
The Chart
Readers will see that KTOS is breaking out of a more than two-year-long rising regression model. The stock has tried to breakout to the upside since the start of November and this morning's news may have gotten the job done. Readers will also see a strengthening RSI and within the daily MACD, a bullish crossover of the 26-day EMA by the 12-day EMA, while the histogram of the nine-day EMA moves into positive territory.
Should the stock find support at the upper trendline of the model ($28), that becomes my pivot and would allow for a target price as high as $35. My idea, in minimal lots would be to purchase 100 shares of KTOS at or close to the last sale of $29, then go out to May 16 expiration (post-earnings) and sell one $25 put for about $1.45 and sell one $35 put for roughly $1.25.
These options sales would take the stock's net basis down to $26.30, while exposing the trader to the risk of having to double that long position at $25, and capping profits through mid-March at $35. By the way, a $35 sale with that net basis would amount to a gain of 33%.
At the time of publication, Guilfoyle had no positions in any securities mentioned.
