Cubic Corporation

Positive Review

$1.3 Billion

Latest Research Note

Cubic's year is up on the Top Buys portfolio, and although this was a Magic Formula stock as recently as yesterday (it dropped off today), we're going to sell it and move on. I still like the company but there look to be numerous better opportunities in MFI right now. Cubic had a pretty weak Q3, especially in the defense division where revenues declined 20%, but backlog was solid at $2.8 billion and I still like Cubic's transportation business very much. On the down side, the fact that the company is 95% dependent on government spending for revenues is a bit worrisome (particularly for the defense divisions), and I think the $59 price target is about $5 too high for the near term. Also, the dividend is miniscule and the company does not buy back stock. Still, there is upside here if you like the company.

I will be keeping an eye on Cubic for a future re-recommendation.

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Business Summary

Cubic Corporation is a government contracting firm with three business segments. Mission Support Services (MSS, 38% of sales, 19% of operating income) provides military training services, organizes and implements mission simulations, and provides fields operations and maintenance. MSS can be thought of as the "service arm" of Cubic's defense offerings. The "product arm" is Cubic Defense Systems (CDS, 29% of sales, 29% of operating income). CDS provides virtual training system simulators, instrumentation for fighter aircraft and armored vehicles, and laser-based tactical and communications devices. The third segment is Cubic Transportation Systems (CTS, 30% of sales, 52% profits), which develops, implements, and operates fare collection systems for public transit systems around the world, from issuing fare cards to installing gates and computerized tracking systems. About 58% of sales are to the U.S. government, with the bulk of remaining sales coming from state or foreign governments.

Growth Strategy

The transportation division is the most attractive from a growth standpoint. At the end of Q3 2010, CTS backlog grew 42%, while backlog at MSS and CDS was down 10% and 7%, respectively. In January, Cubic won a $220 million contract to expand and operate Vancouver's mass transit ticketing system. Mass transit expansion is expected in London for the 2012 Olympics, and the company is pursuing deals in Germany and India. Cubic has increasingly won outsourcing deals to supply operations and maintenance to installed fare systems, a great source of recurring revenue. More deals like this are likely in the future. MSS and CDS revenues are historically lumpy, although Cubic's training and simulation offerings are well-suited to the evolving nature of a more nimble military. The company's backlog and recent strength in CTS should bode well over our one-year holding period.

Competitive Position

Cubic's business has excellent built-in moat factors. Defense contracting by nature has a lot of inertia, and Cubic has over 30 years of experience. Additionally, its offerings are well-suited to the evolving priorities of the Defense Department. The mass transit business is even more attractive. Cubic is by far the largest supplier of these systems worldwide. The company services over 40 major metropolitan markets, including London, the largest mass transit system in the world. This track record gives Cubic an immediate leg-up in winning new contracts. Once these systems are in place, there are very high switching costs involved in moving to a competitor's offering - particularly in a regional setup where multiple forms of transportation (rail, bus, ferry, etc.) are tied into a single system. Management continues to work towards winning operational contracts (Cubic manages the fare system), with very predictable recurring revenues on top of design and installation payments.


Cubic earns 58% of revenues from the U.S. government, and a significant portion of the remainder from state and local governments. With a clear political focus right now on cost control, Cubic faces the risk of some of its defense contracts getting cut. This has been evident in MSS over the past year, and will probably continue to weigh on sales and backlog. 71% of sales stem from fixed-price contracts, which face the risk of cost overruns. Mass transit contracts are rare and as such are highly competitive. This can limit initial profitability and makes the event risk of missing a big contract significant.


93 year old Walter Zable has held all the major titles (CEO, Chairman, President) for almost 50 years, and maintains 40% ownership of the company. The principal officers of the company are experienced and long-tenured, with about a decade with the company on average. Results have been good with this group. Cubic does not use restricted stock or options to pay employees, which can be seen in a perfectly flat share count for many years. While I think this team is solid, there are a couple of concerns. Zable's age and considerable holdings could lead to heavy insider sales, bringing the stock price down. Also, the board of directors is quite old, with all 9 over 60 and 4 that are 70 or older. This could cause significant turnover in the near future.

Financial Health

Cubic is in good financial health. Cash on the balance sheet totals $339 million, vs. just over $16 million in total debt. The company has a long track record of outstanding free cash flow creation, with cash averaging 130% of operating earnings over the past 5 years. For comparison, most firms come in at around 70-75%, meaning Cubic generates very high quality earnings. Operating margins have been on a steady rise for 5 consecutive years, currently sitting just over 8%. The firm pays a small dividend that yields about 0.5% at current share prices. The dividend has been static for many years, but has room to rise.

MagicDiligence Opinion

Cubic is a small, well-run provider of defense, security, and transportation systems. The security and transportation units, in particular, play into evolving government priorities. Increasing urbanization and traffic to energy efficiency and intermodal mass transit, make Cubic's transportation fare offerings a strong long-term growth catalyst. Anti-terrorism and intelligence efforts drive demand for security services. Cubic does face risk from government spending cuts, with over 95% of sales from governments. This makes future growth hard to predict, and investors should leave a large margin of safety to the $59 sell early target.

Company Description

Cubic Corp. engages in designing, development, production, installation, maintenance and operation of automated fare payment, traffic management and enforcement solutions, real-time information collection systems, and revenue management infrastructure and technologies for transportation agencies. The company operates through three reportable business segments: Cubic Transportation Systems, Cubic Defense Systems and Mission Support Services. The Transportation Systems segment designs, produces, installs and services electronic revenue collection systems for mass transit projects, including railways and buses. The Defense Systems segment performs work under the U.S. and foreign government contracts relating to electronic defense systems and equipment. Its products include customized military range instrumentation, laser based training systems, virtual simulation systems, communications products including datalinks, power amplifiers, avionics systems, multi-band communication tracking devices, and cross domain hardware solutions to address multi-level security requirements. The Mission Support Services segment provides training, operations, intelligence, maintenance, technical and other services to the U.S. government and allied nations. Cubic was founded by Walter J. Zable in 1949 and headquartered in San Diego, CA.

Steve does not own CUB.

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