Leidos’ valuation is approaching buy territory.
Nov. 21 was a big day for Pentagon defense contracts — and for Boeing (BA -1.75%) in particular. The U.S. Air Force, Navy, and Defense Logistics Agency made three separate contract awards to the giant defense contractor — for the production of refueling tankers and maritime surveillance aircraft, and for maintenance work on V-22 Osprey tilt-rotor planes. These contracts allocated just under $4.7 billion in funding, making for one of Boeing’s most lucrative business days of the year.
On that very same day, though, a smaller U.S. Army award was allocated to another defense company, with which you may be less familiar. Based in Huntsville, Alabama, Dynetics is a one-time private aerospace company that defense tech specialist Leidos (LDOS -0.37%) snapped up for $1.7 billion in late 2019. Five years later, the Army has awarded this Leidos subsidiary $670.5 million in a single contract, to conduct research and development on hypersonic missiles.
What you need to know about Leidos
Reporting on the award, The Defense Post noted that Dynetics is part of a team of contractors led by Lockheed Martin, working on long-range hypersonic weapons (LRHWs) for the Army, and conventional prompt strike (CPS) hypersonic missiles for the Navy.
The Pentagon’s contract award contained few details on Dynetics’ assignment, noting only that it involves the “glide body and thermal protection system” for hypersonic weapons systems. But the Pentagon did mention that although the Army published a broad invitation for bids for its hypersonics work, only one company felt qualified enough to bid on it: Dynetics (which now means Leidos).
And that caught my interest.
I’ve been following Leidos as a defense stock for some years now. I discussed the stock briefly earlier this year when surveying valuations (and concluding that, by and large, defense stocks cost too much); I noted that among 10 large defense stocks, Leidos stood out as the single best-performing defense stock in the U.S., having more than tripled in share price over the last seven years.
Even more interesting is Leidos’ potential to keep on outperforming the rest of the defense industry.
Valuing Leidos
Consider: From 2003 through 2023, the valuation of Leidos stock averaged an enterprise-value-to-free-cash-flow (EV/FCF) ratio of 1.3. That’s similar to the stock’s current enterprise-value-to-sales (EV/S) ratio of 1.6, and price-to-sales (P/S) of 1.4. Meanwhile, the average defense stock today has an EV/S of 2.2 and a P/S of 1.8.
Compared to others in the industry, Leidos’ stock looks relatively cheap.
Leidos also looks attractive when considered on its own merits. Valued at just under $22 billion in market capitalization, for example, the stock sells for a relatively attractive price-to-earnings (P/E) ratio of just 18.2. Relative to its 15.4% long-term expected earnings growth rate and its 1% dividend yield, that gives the stock a total return ratio of 1.1 — within 10% of “fair value.”
Additionally, strong free cash flow (relative to reported net income) gives the stock a price-to-free-cash-flow (P/FCF) ratio of 17.4. Substituting FCF for net income gives the stock a total return ratio even closer to fair value.
Is it time to buy Leidos stock?
While all these calculations suggest that Leidos isn’t quite “cheap” just yet, it does appear to be cheaper than almost any other defense stock. At the same time, Leidos is coming off a strong third-quarter earnings report: It featured better than expected sales and earnings, an upwards revision to guidance, and (perhaps best of all) confirmation of tremendous momentum in contract wins.
New contracts won during the quarter (bookings) outmassed bills for work performed (billings, or revenue) by nearly 2 to 1. (To be precise, the company’s book-to-bill ratio was 1.9.) And this was before Leidos was awarded its new $670.5 million hypersonics contract, which arrived after the close of the quarter.
Viewed in light of the stock’s already defensible valuation — one verging on bargain territory — the company’s strong bookings performance in Q3, plus its big hypersonics win early in Q4, all suggest that big things lie ahead for Leidos. While not a bargain yet, it’s close enough to fair value to be worth watching in case the stock market suffers a pullback.
Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
