Company Overview: Leidos Holdings, Inc. (NYSE: LDOS) is a global science and technology company, engaged in providing technology and engineering services and solutions in the defense, intelligence, civil and health markets. The group merged with the Information Systems & Global Solutions business of Lockheed Martin Corporation in August 2016, in a Reverse Morris Trust transaction. The acquired Information Systems & Global Solutions business was retitled as Leidos Innovations Corporation.

LDOS Details

LDOS Rides on Contract Wins & Acquisition Synergies: Leidos Holdings, Inc. (NYSE: LDOS) provides solutions and services to solve the world’s toughest challenges in the defense, intelligence, homeland security, civil, and health markets, and had derived over 87% of their total revenues in fiscal year of 2019 from contracts with the U.S. Government. LDOS primarily supports the federal government's evolving information technology (IT) needs. Presently, the company operates through three business segments namely — Defense Solutions, Civil, and Health.

Defense Solutions provides surveillance and reconnaissance, worldwide services and integrated systems solutions for military commands, the U.S. Intelligence Community, and other commercial and government customers. In 2019, this division generated sales of $5,367 million, providing 48.4% to total business sales. Civil segment provides aviation solutions, security products, enterprise IT services, federal environment, and infrastructure solutions as well as logistics. The segment’s sales in FY19 stood at $3,729 million, accounting for 33.6% of total business sales. Coming to Health segment, it provides cost-effective solutions to federal and commercial customers, which are responsible for the health and well-being of people worldwide comprising service members and veterans. Sales at this division totaled $1,998 million in FY19, representing 18% of the total business sales.

In May 2020, the company wrapped up the buyout of Security Detection and Automation business of L3Harris Technologies, Inc. (NYSE: LHX) for $1 billion. Remarkably, the synergies from this acquisition are expected to bolster the company’s top-line performance, going forward. The company’s defense sector has persisted to remain more resilient to the novel coronavirus led uncertainties. With LDOS generating almost half of its revenues from the Defense Solutions segment, constant order growth from Pentagon and other U.S. associates is expected to boost defense revenues.

The company witnessed a CAGR of 16.4% and 39.7% in revenue and net income, respectively, over the period of FY16-FY19. The company’s results are likely to benefit from a robust product portfolio, which, in turn, will boost the top-line and support the growth. The company’s capability to enhance the customer base along with acquisition synergies is expected to be a tailwind in the near-term.

Past Performance (Source: Company Reports)

Amid COVID-19 pandemic, the company has been exploring prospects in its health business in order to develop and offer virtual care solutions, to aid a wide range of actions from patient intake and pre-screening to virtual appointments through remote supervision within the hospital, or other care environments. These are expected to boost new program revenues for the company, going forward.

LDOS Witnessed Growth in 2QFY20 Top-line & Bottom-line: During the quarter, the company reported adjusted earnings of $1.55 per share, up 33.6% from $1.16 per share reported in the year-ago period. GAAP earnings came in at $1.06 per share in 2QFY20, up from 93 cents reported in the year-ago period. Total revenues for the period came in at $2,914 million, up 6.8% year over year, owing to growth across all segments, except Health. Total cost of revenues in the quarter stood at $2,531 million, up 7.8% year over year. Operating income increased 18.6% year over year in 2QFY20 and came in at $249 million. During the quarter, the company reported, adjusted operating income margin of 11.2%, up from 9.4% reported in 2QFY19, owing to the net gain recognized upon the receipt of proceeds associated to the VirnetX legal matter and program wins. Interest expenses for the period came in at $41 million.

Second Quarter FY20 performance (Source: Company Reports)

At the end of 3 July 2020, LDOS’s total backlog was $30.7 billion, up from $28.3 billion at the end of the previous quarter. Of this total backlog, $7 billion was funded.

Backlog (Source: Company Reports)

Segmental Performance: During the quarter, the company reported growth across all the segments, except Health unit.

Defense Solutions: In 2QFY20, the company reported net revenues of $1,757 million, up 12.6% year over year, primarily due to revenues related to the Dynetics acquisition, program wins and a net increase in program volumes. Furthermore, the segment’s operating income improved from $113 million reported in the year-ago quarter to $119 million.

Defense Segment Highlights (Source: Company Reports)

Health: Revenues from this segment came in at $399 million, declining 20.4% year over year. The revenue decrease was due to delay in program execution due to COVID-19 led crisis, the impact from the sale of LDOS’s health staff expansion business and the completion of certain contracts. This was partially offset by the acquisition of IMX Medical Management Services, Inc.

Health Segment (Source: Company Reports)

Civil: In 2QFY20, revenues at this segment increased 13.6% year over year and came in at $758 million, primarily due to program wins and a net increase in program volumes. While operating income from this unit came in at $78 million, up 39.3% year over year.

Civil Segment (Source: Company Reports)

Balance Sheet Highlights: The company exited the quarter with cash and cash equivalents of $588 million, with long-term debt, net of current portion, amounting to $4,148 million. Net cash provided by operating activities during the quarter stood at $422 million, up from $186 million reported in the year0ago period. Notably, robust cash flow and borrowing capacity provide ample capital to the company for continued investment and available liquidity for unforeseen events.

Cash Flow Sneak Peek (Source: Company Reports)

Contract Wins Remain a Key Catalyst: Recently, the company stated that it has been awarded a prime contract for ~$292 million by the Federal Aviation Administration (FAA). As per the contract, LDOS will design and advance a system to deliver real-time access to vital weather, aeronautical, and National Airspace System (NAS) information via NAS-wide Enterprise - Information Display System (E-IDS).  Other contracts won by the company include a $649 million, single-award Indefinite Delivery/Indefinite Quantity (“IDIQ”) contract to support the SOCOM community with tactical ISR operations, system integration, and sustainment in numerous locations within the Contiguous United States (CONUS) and Outside the Contiguous United States (OCONUS). Looking ahead, the company is set to gain from several government contracts, which lends stability to its business and manages variation in revenues.

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together forms around 35.35% of the total shareholding. The Vanguard Group, Inc. and JP Morgan Asset Management hold the maximum interests in the company at 11.16% and 5.25%, respectively.

Top 10 Shareholders (Source: Refinitiv, Thomson Reuters)

Key Metrics: The Company reported Jul’20 EBITDA margin at 11.7%, higher than Apr’20 figure of 9%. Net margin for the same time span stood at 5.3%, higher than the industry median of 4.6%. ROE, in Jul’20, stood at 4.4%, higher than the industry median of 2.3%.

Key Metrics (Source: Refinitiv, Thomson Reuters)

Key Risks: The company is heavily dependent on U.S. government agencies as its primary customer, as a result, the loss of any of these agencies could unpleasantly impact future revenues and cash flows. Further, increasing expenditure due to the impact of COVID-19 led pandemic are the potential headwinds. For instance, to deal with COVID-19 crisis, the company has enabled teleworking capabilities via hardware software and cloud-based service deployments. To support this, the company has been hiring aggressively. This along with acquisition related expenses can weigh on financial performance. Additionally, competition from peers and a leveraged balance sheet adds to the woes.

Future Expectations: For FY20, the company expects adjusted earnings to be in the range of $5.25-$5.55, up from the prior outlook of $5.00-$5.30 per share. Revenues for FY20 is expected to be in the range of $12.2-$12.6 billion. The company expects cash flow from operating activities to be at least $1.2 billion, up from the previous view of $1 billion.

FY20 Outlook (Source: Company Reports)

Key Valuation Metrics (Source: Refinitiv, Thomson Reuters)

Valuation Methodology: EV/Sales Multiple Based Relative Valuation (Illustrative)

EV/Sales Multiple Based Valuation (Source: Refinitiv, Thomson Reuters)

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months

Stock Recommendation: The stock of LDOS closed at $88.34 with a market capitalization of ~$12.6 billion. The stock made a 52-week low and high of $68 and $125.84, respectively and is currently trading below the average of its 52-week trading range. The stock went up ~13.3% in the last six-month period. The company’s mission-critical work, long-term contracts, a flexible operating model, and cost structure, along with supportive government customers are expected to aid the company’s growth, going forward. Considering the above factors, we have valued the stock using an EV/Sales multiple based illustrative relative valuation method and arrived at a target price with an upside of lower double-digit (in % terms). For the purpose, we have taken peers like Northrop Grumman Corp (NYSE: NOC), General Dynamics Corp (NYSE: GD), Lockheed Martin Corp (NYSE: LMT), to name few. Hence, we recommend a “Buy” rating on the stock at the closing price of $88.34, up 1.34% on 14 September 2020.

LDOS Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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