Here's the value proposition: Leidos (“LDOS”) has historically performed with an 8% free cash flow yield. No volatility. It's like God wrote it in stone: LDOS should not have an 7.5% yield and it shall not yield an 8.5%. Along the way it's performed slightly above the market for years.
The company that traded at 110 in January 2020, 110 in February, 2021, and 110 in March, 2022, is situated to trade there yet again.
There's two reasons. The first is simple. Last year 87% of its revenue came from contracts with the US government. The next few years that proportion is going to be the exact same while LDOS continues to earn more and more revenue.
The logic behind the 8% is then obvious. Government contracts are funded (or obligated) years in advance. There's no surprises for investors. The money goes in, the money comes out. It's public record and LDOS, for its part, also reports out on the contracts it has that are funded/obligated.
The second feeds off this, since management and investors go into the company eyes wide open there isn't volatility. As LDOS has grown revenue, they increase the dividend. Thus, the stock goes back down because less FCF. When the stock goes down too much, management buys back some stock / waits for revenue growth. This little ecosystem that trades as LDOS has been disturbed by larger market forces that have nothing to do with its already conservative valuation.
LDOS was already trading around 20-40% discounted from peers when looking at forward PE ratios — https://ibb.co/chLHsd2. But since LDOS current stock price has fallen even lower it's a buy. Its contracts are still there. The U.S. Government still exists. The company that guided for 8% yield for 2022 in 2021 is the same company that now guides for 8% in 2023 — that is, if its stock and market capitalization hadn't shit the bed.
To be clear, if you are looking for moons and rocketships this is not the due diligence for you. This is the due diligence for those who want to round out their portfolio with an unexciting albeit profitable defense services stock that wins hundreds of millions of dollars in contracts for things that you don't even know exist. Along the way it also gives you a bit of dividend, which is nice. Invest in this stock enjoy a little 13% return, maybe hope for more, and then hold it until you die.
Revenue has increased each year over at least the past five years, climbing from $10.17 billion in 2017 to $13.74 billion in 2021. What's more, management has high hopes for the 2022 fiscal year. They anticipate sales of between $13.9 billion and $14.3 billion. At the midpoint, this would imply $14.1 billion. If that comes to fruition, it would translate to a year-over-year increase of 2.6%. The last quarter, they're aiming for dead center of the midpoint.
As revenue has risen, so too has profitability. Between 2017 and 2021, net income at the business expanded, climbing from $366 million to $753 million. With earnings per share expected to be between $6.10 and $6.50 for the 2021 fiscal year, that should translate to net profits, at the midpoint, of $885.2 million.
LDOS also raised its dividend by 6% to 36 cents a quarter late last year. While the yield is still small, do keep in mind that the payout ratio is incredibly small as well. With a 22% payout ratio, LDOS can comfortably keep raising the dividend and provide investors with a steady and growing dividend yield.
The big issue has been inflation eating into its margins, with YoY decreases in margins apart from its Health sector.
Defense Solutions 6.5% <-- 7.8%
Civil 5.4% <-- 9.7%
Health 18.2% <-- 17.3%
Total 7.8% <-- 9.3%
But ultimately this headwind is for knocking a few bucks off its price, not 10%.
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