Can Booz Allen (BAH) Continue Its Bull Run?
Booz Allen Hamilton (BAH) is yet another entry from one of Magic FormulaŽ Investing's (MFI) favorite industry sectors - defense and government contractors. The stock is up nearly 30% over the past 3 months, riding the defense bull market along with several fellow MFI stocks like Northrop Grumman (NOC) (up 21%), Lockheed Martin (LMT) (also 21%), and Exelis (XLS) (up an impressive 37%).
The key questions are - does the defense market have the ammo to blast higher, and how is BAH positioned to benefit if so?
Booz Allen has been in the government consulting game for a long time, since World War II. Today, 99% of revenues come from Uncle Sam. 55% of sales are to defense clients - the Army, Navy, Air Force, Marines, and other Department of Defense (DoD) agencies. 23% of sales are to the intelligence community - the NSA and other "classified" agencies. The remaining 22% are to civil government departments, primarily in the disciplines of financial services, health, security, and justice / law enforcement.
Government contractors provide all kind of services, but Booz Allen's fall into a few categories. Management Consulting and Operations is the biggest one, providing project management, supply chain logistics, analysis and implementation for intelligence, military, healthcare, and other department concerns. The company also supplies contractors for technical and engineering implementations - the people who implement and build the systems and tools spec'd by the consulting guys.
Revenue growth over the next several years will be a challenge. Sequestration went into effect on March 1. As a result, federal defense spending is expected to fall 6% this year and about the same for 2014, and grow at about 2% after that through 2023, which is far below the 7% growth rate experienced from 2000-2012.
Booz Allen's results have mirrored this - revenue was down 1.7% in fiscal (March) 2013, and forecast to be down about 2% for 2014. The company has relied on acquisitions (such as ARINC) to expand service offerings in important strategic areas, and is re-entering the commercial market. Improving margins have also been a catalyst - restructuring and tight management of headcount has allowed Booz to raise operating margins from under 4% in 2010 to 7.7% last year. As a result, BAH has actually grown operating earnings at a 12% compound growth rate over the past 3 years.
However, further margin upside is likely limited. Close comparables to BAH (like SAIC (SAI) and ManTech (MANT)) run margins right around the 8% mark. I'm dubious as to how much more management can squeeze out of the business model.
So the story here is one of mediocre-to-no revenue growth, limited margin upside, a fair-but-middling regular dividend (2.1%), and no history of meaningful share buybacks. Booz did pay a massive $8/share in special dividends during 2012, but we've missed the boat on that and the balance sheet was dirtied up as a result ($1.7 billion in debt vs. $350 million in cash). Some have tried to pin leaker and former employee Edward Snowden as a risk on BAH, but I don't see it - the military has already admitted no wrongdoing on the company's part.
Given all this, Booz Allen does not look like a particularly interesting Magic FormulaŽ pick at this point in time. My price estimation was $18.50/share, actually slightly below current trading prices. We'll pass on this name and look for more attractive opportunities.
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