Leidos Holdings Inc. (NYSE: LDOS), a provider of technology and engineering services to defense, intelligence, homeland security, and healthcare customers, is one of the best stocks to buy according to some analysts. Leidos is well positioned to take advantage of Defense spending trends that focus on cybersecurity and data analytics, among other priorities. The company is seeing strong bookings and has just completed an accretive acquisition. The acquisition has weakened the balance sheet, but management is prioritizing paying down debt.
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The beta on LDOS is 1.00.
On November 2, Leidos reported that 3Q revenue rose 14% year-over-year to $3.2 billion. The adjusted operating margin was steady at 10.7%. Above the consensus outlook of $1.23. Bookings of $4.3 billion resulted in a healthy book-to-bill ratio of 1.3, and a backlog of $31.7 billion, up 3% from the previous quarter.
In 2020, management expects COVID-19 to adversely impact revenues by approximately $300 million. In response, the company has indirectly reduced costs and driven program performance in order to maintain margins.
Along with the 3Q earnings release, Leidos updated its 2020 guidance. Management now expects 2020 EPS of $5.65-$5.85, up from a prior outlook of $5.52-$5.50, and revenue of $12.3-$12.5 billion, compared to the earlier outlook of $12.2-$12.6 billion. It looks for operating cash flow of more than $1.2 billion.
During 3Q, Leidos closed on the $1 billion purchase of L3Harris’ Security Detection & Automation businesses. The deal is expected to be immediately accretive to revenue growth, adjusted EBITDA margin, and non-GAAP diluted EPS. The new unit, with annual revenue of approximately $500 million, adds a strong presence in the airport security and automation market, and diversifies revenue through an expanded international footprint.
EARNINGS & GROWTH ANALYSIS
Defense Solutions (62% of 3Q revenue); Civil (24%) and Health (15%). Recent results by business segment are summarized below.
Defense Solutions: This segment includes Defense & Intelligence and Advanced Solutions, and provides cybersecurity, data analytics, and software development services to the Department of Defense, Department of Homeland Security, U.S. intelligence agencies, and U.S. allies. Third-quarter segment revenue rose 22% from the prior year, driven by acquisitions; organic revenue rose 3.5%. Looking ahead, we anticipate mid-single-digit growth from this group for the next several quarters, with modest margin improvement. Bookings have been strong.
Civil: The Civil segment provides software development and related services to U.S. government agencies as well as commercial customers. The L3Harris operations have been added to this group. Segment revenue increased 5% due to the acquisition, partly offset by the impact of COVID-19. The non-GAAP operating margin widened by 220 basis points to 10.5% due to a better program mix. We look for margin improvement in 2020, driven by continued solid revenue growth.
Health: The Health business provides software development, data analytics and electronic health records implementation services for government agencies and commercial healthcare providers. Revenue rose 6% year-over-year in 3Q on an organic basis, reflecting program wins.
FINANCIAL STRENGTH & DIVIDEND
LDOS had $588 million in cash and cash equivalents and $5.0 billion in notes payable. The company’s cash flow conversion ratio in 2Q was a healthy 169%.
During 3Q19, the board boosted the dividend by 6%, to an annualized $1.36. Management has said that it will continue to prioritize the use of excess cash to maintain the regular dividend, though we expect growth to slow as the company pays down debt.
MANAGEMENT & RISKS
Roger Krone has been the chairman and CEO of Leidos since July 2014. Prior to Leidos, he held senior management and finance positions at Boeing, McDonnell Douglas, and General Dynamics. James Reagan has been EVP and CFO since July 2015, and principal accounting officer since January 2016. From 2012 to 2015, Mr. Reagan served as SVP and CFO at Vencore, Inc., a provider of information solutions and engineering and analytic services to the U.S. Department of Defense.
The company has set financial goals (prepandemic), including:
— 3% revenue growth
— 10%+ adjusted EBITDA margin
— 100%+ cash efficiency
LDOS investors face risks related to COVID-19, increased industry competition, the company’s reliance on government spending, and high levels of goodwill and other intangible assets on the balance sheet.
Leidos Holdings is a provider of technology and engineering services to defense, intelligence, homeland security, and healthcare customers. The shares are a component of the S&P 500. The company has 37,000 employees.
The recent trend is more neutral. On the fundamentals, the metrics appear generally favorable.
On November 10 at midday, BUY-rated LDOS traded at $95.18, up $0.55.