1、North America Equity Research24 September 2019Equity Ratings and Price TargetsMkt CapRatingPrice TargetCompanyTicker($mn)Price($)CurPrevCurEnd DatePrevEnd DateBooz Allen HamiltonBAH US9,869.1769.93N77.00Dec-20CACI InternationalCACI US5,754.25227.01N250.00Dec-20Leidos HoldingsLDOS US12,510.7485.69N95
2、.00Dec-20Science Applications International CorporationSAIC US4,951.4083.78OW102.00Dec-20Source:Company data,Bloomberg,J.P.Morgan estimates.n/c=no change.All prices as of 23 Sep 19.Aerospace and DefenseDefense Services Initiation:Upside Has Moderated on Good YTD Performance but Value Remains at SAIC
3、 Aerospace&DefenseSeth M.Seifman,CFA AC(1-212)622-Bloomberg JPMA SEIFMAN J.P.Morgan Securities LLCBenjamin E Arnstein,CFA(1-212)622-J.P.Morgan Securities LLCMichael S Rednor,CFA(1-212)622-J.P.Morgan Securities LLCAnirvan Bordoloi(91-22)6157-J.P.Morgan India Private LimitedSee page 55 for analyst cer
4、tification and important disclosures,including non-US analyst disclosures.J.P.Morgan does and seeks to do business with companies covered in its research reports.As a result,investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report.Inves
5、tors should consider this report as only a single factor in making their investment decision.We are initiating coverage of four Government Services stocks:SAIC(OW),BAH(N),CACI(N),and LDOS(N).Our top pick is SAIC,a value play with20%upside to our Dec 2020 price target and limited downside.Upside for
6、the remaining stocks is 10%+,with each offering something different.CACIs move into products is attracting investor attention but is still in the early stages.BAH is the highest quality services name but valuation limits upside,even with our above-consensus estimates.We see similar upside for LDOS,a
7、 diversified bellwether with more civil exposure,particularly in healthcare.(See page 4 for our Services“cheat sheet”and page 5 for our estimates vs consensus.)With growth and visibility,Services stocks are appreciated again.With growing backlogs and a budget deal through FY21 investors feel comfort
8、able with sales visibility into the early 2020s.Meanwhile,Services companies have little exposure to macro risks or trade concerns,which has helped make them attractive this year:BAH,CACI,and LDOS have each outperformed the market by 35 points YTD while SAIC has outperformed by 10%.Service providers
9、 pursuing higher end capabilities.A historical knock on Services companies has been that they do less sophisticated work than Product peers,leaving them vulnerable to price pressure.Today,Services remains more competitive than Products and margins are lower,but Services companies are seeking to asce
10、nd the value chain,sometimes leading to overlap with Products.The importance of software development enables this trend and it has likely helped the market get more comfortable with the Services value proposition.Valuations elevated,not outrageous.With the exception of SAIC,these stocks trade above
11、their historical P/Es in the mid-teens,which seems reasonable,given organic growth ahead,stable to expanding margins,and cash to deploy.One could argue that Services stocks,with no DB pensions,should trade closer to the Defense Primes pension-adjusted multiples(20 x)but because of habit,visibility,a
12、n ability to drill down into programs,and the value of the primes pension cash inflows,we think this is unlikely.More M&A likely.All four companies have engaged in M&A at times,withCACI most focused on it,using leverage and foregoing cash return;but even BAH,which has prioritized organic growth,is o
13、pen to M&A.In the near term,while we cannot rule out anything transformative,these four companies seem focused on smaller deals,in SAICs case because the company just bought EGL.2North America Equity Research24 September 2019Seth M.Seifman,CFA(1-212)622- We created a growth/outlook framework.These f
14、our stocks now trade in the 13-20 x range on consensus EPS for next FY,with BAH at the top,SAIC at the bottom,and LDOS/CACI in the middle.Our valuation framework,based on growth,profitability,and return on capital,is largely in line with this rank order(see page 16).The wider multiple dispersion on
15、FCF(10-23x),along with the fact that CACI has not typically seen a P/E premium for higher FCF conversion suggest to us that P/E is the appropriate metric for this group.SAIC offers 20%upside with limited downside.While there are valid concerns on both growth and profitability following the recent En
16、gility acquisition,we see limited downside based on the multiple and our estimates.Our PT is$102,based on 14x CY21 adj.EPS of$7.30.With 5%upside on EPS and a 15x multiplestill below LDOS and CACIthere is 35%upside.Meanwhile,if EPS misses our estimate by 25%,the stock would still have to trade 12x to
17、 yield downside equal to the 20%upside in our base case.CACI expanding toward products.1)CACI has been the groups top performer in recent weeks and has highlighted its opportunities to grow in higher margin Mission Technology work,which includes manufacturing similar to some activities at L3Harris.W
18、e believe this last part remains a small part of the sales baseperhaps a mid-single-digit percentage of sales at mostbut the opportunity is interesting and something we will watch.(See page 28 for more information.)BAH should be primed to deploy capital.With at least$350 mn of excess cash on the bal
19、ance sheet and leverage that is half a turn below where it has been in recent years,we would not be surprised to see BAH deploying cash soon,either through a special dividend,share repurchases,M&A,or some combination.Our Dec 2020 price target of$77 is based on an 18.5x multiple and our CY21 EPS esti
20、mate of$4/share plus a small benefit for incremental capital deployment.(We already assume basic repurchases in our published estimate.)Important awards approaching for LDOS.The company faces a major re-compete for its Hanford nuclear site management work with the Department of Energy and we could s
21、ee an award any day for a contract worth$500 mn annually for 10 years.GSM-O,another re-compete,should see award soon as well,while LDOS seeks to win new work on the NGEN contract,which the Navy just extended by 4-7 months.3North America Equity Research24 September 2019Seth M.Seifman,CFA(1-212)622-Ta
22、ble of ContentsKey Investment Points.5Defense Services Landscape.8Industry Fundamentals.8Organic Growth Is Correlated with DoD O&M Outlays.11Services Margins Trail Their Products Peers.13Services Companies Trading Near or Above Historic Avgs.16M&A Remains A Key Aspect of Capital Deployment.20DSOs dr
23、ive cash flow for the Services Companies.22Booz Allen Hamilton.23Investment Thesis.23Might Booz see growing pains?.24Company Description.25Top Line Growth Supports the Cash Ramp.25Valuation.26CACI International.28Investment Thesis.28How much more productive can CACI be?.29Company Description.30M&A a
24、nd Mix to Drive Financials.30Valuation.32Leidos.34Investment Thesis.34Large Contracts Pose Largest Risks to LDOS.35Company Description.36Large Diversified Portfolio Supports Financial Outlook.36Valuation.38SAIC.40Investment Thesis.40Integration and Moving up the Value Chain are Key Risks.41Company D
25、escription.42Integrating Engility Drives Financials.42Valuation.44Booz Allen Hamilton.47CACI International.49Leidos Holdings.51Science Applications International Corporation.534North America Equity Research24 September 2019Seth M.Seifman,CFA(1-212)622-The“cheat sheet”below is a simple look at releva
26、nt qualitative and quantitative information for Services stocks.Table 1:Defense Services Cheat SheetMetricBAHCACILDOSSAICAnnual Sales($bn)$7 bn$5.5 bn$11 bn$6.5 bnOrganic Growth6-9%target through FY21Outgrow underlying market:implies 6%5%CAGR 2019-20213%CAGR FY20-FY22,implying accelerationAdj EBITDA
27、 TargetLow 10%10.3%guide with 10-30bp annual expansion10%+9%by FY22Cash Conversion80 to 90%of adj net income110 to 120%of GAAP net income100%of adj net income100%of adj net incomeCapital Deployment StrategyCash return to shareholders but may look more at M&A;has paid special divs Strong M&Apreferenc
28、e$200mn in dividends annually and$1.5bn in M&A or share repo through 2021Excess cash to shareholders through repurchases;bolt-ons possibleEmployees(6/30/19)26,384 22,000 33,000 23,000 Leverage(Net debt to LTM PF)2.2x3.6x2.2x3.4xInvestment ThesisLimited upside to our price target at 18.5x EPS plus ca
29、p deployment Seeking confidence in product focused strategy Solid portfolio but size,diversity make it harder to differentiate;some re-compete riskToo cheap to ignore:discounted multiple and achievable targetsUpcoming CatalystsDeploying excess cash to shareholdersPossible M&AHanford,GSM-O Re-compete
30、s and NGEN takeawayDoJ asset forfeiture contract protest;return to organic growthIncentive CompMetricsAdj EBITDAAdj EPSRev ex billable expensesNet After-tax ProfitEPSTotal RevenueDirect LaborAdj.Op.IncomeTotal BacklogDays WCRevenueAdj.EPSAdj.EBITDAAdj.RevenueAdj.Op.Cash FlowAdj.Op.IncomeCommentHighe
31、st quality portfolio,focused on classified and intelligenceAims to continue Using M&A to move into higher value areas,esp products with some LHX like aspirations Largest,well-diversified Services company;unique focus on Health Most traditional services portfolio and therefore perceived as lower qual
32、ity but already trades at a discount Source:Company reports and J.P.Morgan estimates.5North America Equity Research24 September 2019Seth M.Seifman,CFA(1-212)622-Table 2:JPMe vs.ConsensusRevenues($mn)EBITDA($mn)EPS($)FCF($mn)JPMe1FY2FY3FY1FY2FY3FY1FY2FY3FY1FY2FY3FYBAH7,420 7,977 8,401 764 832 887 3.2
33、0 3.70 4.15 367 441 499 CACI5,605 5,896 6,132 583 629 660 12.35 13.55 14.35 363 399 435 LDOS10,833 11,375 11,943 1,080 1,140 1,201 4.80 5.45 5.90 700 766 818 SAIC6,428 6,717 6,986 538 591 632 5.45 6.35 7.30 424 454 482 Revenues($mn)*EBITDA($mn)EPS($)FCF($mn)Consensus1FY2FY3FY1FY2FY3FY1FY2FY3FY1FY2FY
34、3FYBAH7,285 7,826 8,436 745 817 885 3.11 3.50 4.03 370 426 485 CACI5,622 5,916 6,061 580 623 668 12.15 13.65 15.33 358 412 456 LDOS10,832 11,417 11,743 1,088 1,152 1,225 4.71 5.23 5.81 713 783 833 SAIC6,431 6,741 6,899 540 587 622 5.60 6.26 7.23 449 480 515 Revenues($mn)EBITDA($mn)EPS($)FCF($mn)+/-%
35、1FY2FY3FY1FY2FY3FY1FY2FY3FY1FY2FY3FYBAH1.9%1.9%-0.4%2.6%1.9%0.2%2.7%5.8%2.9%-0.7%3.7%2.9%CACI-0.3%-0.3%1.2%0.6%1.0%-1.1%1.7%-0.7%-6.4%1.5%-3.3%-4.5%LDOS0.0%-0.4%1.7%-0.8%-1.0%-2.0%2.1%4.2%1.5%-1.8%-2.3%-1.8%SAIC0.0%-0.4%1.3%-0.4%0.8%1.6%-2.6%1.5%1.1%-5.5%-5.4%-6.5%Source:J.P.Morgan estimates,Bloombe
36、rg.*Note:LDOS consensus revenue estimates are based on Median numbers due to comparability.Key Investment Points While investor views of the Defense Services for part of this decade revolved around highly competitive,Lowest Price Technically Acceptable(LPTA)contracting,the landscape has improved and
37、 companies are also looking to distinguish themselves through scale and an emphasis on value-add activities.The LDOS/IS&GS transaction is an example of companies seeking to leverage scale to win larger contracts in a competitive environment,while BAHs focus on cyber and analyticsand CACIs moves furt
38、her into mission technology represent efforts to bring thesebusinesses further up the value chain.Though it is changing as well including through the Engility deal SAIC remains closest to the traditional mold of a government IT service and logistics provider.Major players moving toward higher value-
39、added activities This includes software development,software as a service,and products in select areas.This is one way these companies are seeking to align themselves with the National Defense Strategy,which is focused on developing high-end technology to address peer-level threats.Services companie
40、s believe that they can better differentiate their capabilities in these outcome-based efforts vs traditional services work based on earning a fee for employees time.Despite efforts to move the sales mix,its difficult to quantify how much of particular Services companies revenue falls into this“high
41、er end”category and they all continue to do more traditional work,such as IT implementations.Also,Defense Services companies are not the next SaaS plays.Even BAH,the leader in high end work,has a gross margin of 25%(or mid 30%ex billable expenses),whereas SaaS companies deliver 80%.BAHs total G&A ex
42、pense is 15%of sales,which includes marketing and internal R&D,whereas SaaS companies spend 50%on R&D+sales and marketing.This 6North America Equity Research24 September 2019Seth M.Seifman,CFA(1-212)622-SaaS spending is intended to capture growth of 20%,whereas BAH is targeting 6-9%organically,a lev
43、el dependent on Congressional appropriations.Table 3:Services Companies Looking to Move Into Higher-Value WorkContractorContractAgencyAmount($mn)TermCommentBAHInnoVisionNGA3154 yrsProvide scientific and technical researchCACITENCAPUS Army4155 yrsDevelop intelligence gathering softwareLDOSDevOps ODOS
44、 IIDHS(USCIS)93.5Up to 3 yrsProvide software for immigration systemsSAICOASISUS Army(AMRDEC)93Up to 5 yrsSoftware development and scientific researchSource:Company reports.This means more overlap with traditional Defense primes Service providers push into software and advanced technology is leading
45、to increased convergence with the traditional Defense primes,who also develop software to support the operation and upgrade of their products.The primes are also involved in cyber activity,including cyber protection for their own products and they increasingly seek to play in high end areas such as
46、artificial intelligence,which are priorities as DoD pivots toward confronting more sophisticated adversaries.Pursuingthese higher end capabilities could allow service providers to win important new business but it also pits them against some tough competition.On the product side,CACI is taking this
47、furthest,with a small but growing electronics/communications portfolio focused most on the Army that bears some resemblance to parts of L3Harris.We outline some key differences in the industry structure for Services and the Defense Primes and you can see page 7 for more.Table 4:Services vs PrimesSer
48、vicesvs.PrimesShorter cycle O&M spendingRevenue visibilityLonger Procurement horizonsHSD,low incrementalsMarginsLDD,low incrementals but intl helpsMore ID/IQsContractingMore Single Award ContractsMore opportunities for share gain/loss Market ShareContract base is stickierLots of potential targetsM&A
49、Fewer meaningful targets and more anti-trust concernsNo DB obligationsPensionGovt reimburses over time but lots of near term earnings and cash impact,both plus and minus Source:J.P.Morgan.Attracting and retaining talent are criticalSoftware developers and skilled employees are in demand and so succe
50、ssful hiring is imperative for Services companies,who must compete for skilled workers not only with the Defense primes but also with other consulting and commercial businesses.There is an intense focus on employee benefits and the companies are putting forth new retention and training programs to m
