Description
Long VEC (Vectrus Inc.) - $27.19
Overview
Vectrus checks two Greenblatt boxes: it’s a spinoff and a “magic formula” stock.
Vectrus is a spin of Exelis’ military and government services business. They provide infrastructure asset management, logistics and supply chain management, and IT & network and communication systems primarily to the US Army.
The typical dynamic that makes spinoffs attractive is present here. Exelis distributed 1 share of VEC for every 18 shares of XLS. The VEC shares received (a ~280m market cap company) are an insignificant position for most XLS holders, leading to technical selling pressure from indifferent sellers. VEC is also the “bad” business, featuring lower margins, lumpy government contracts, and structural revenue declines from the US drawdown in Afghanistan.
Despite the above issues, Vectrus has several attractive attributes. The business has no CapEx requirements and generates strong cash flows. Costs are employee-based and are easily scalable to meet contract requirements, allowing margins and profitability to be maintained despite declining topline.
Afghanistan Drawdown
Vectrus has generated significant revenue from Afghanistan-based programs. Revenue mirrors US troop count, which has been in decline and is currently expected to reach 0 by the end of 2016. The table below shows revenue projections with Afghanistan broken out:
|
|
2016E
|
2015E
|
2014E
|
2013
|
2012
|
2011
|
|
Total Revenue
|
1,125
|
1,187
|
1,135
|
1,512
|
1,828
|
1,806
|
|
Afghanistan Revenue
|
63
|
125
|
250
|
513
|
625
|
480
|
|
Revenue ex-Afghanistan
|
1,062
|
1,062
|
885
|
999
|
1,203
|
1,326
|
|
Operating Income
|
51
|
53
|
51
|
131
|
110
|
87
|
Vectrus rhymes with… Engility?
This story has been seen before: Engility was spun from L-3 in 2012 for the same reasons as Vectrus’ spin from Exelis today. Even the naming conventions are similar (Vector + Trust vs. Engineering + Agility). The below table illustrates Engility’s strong stock performance despite shrinking topline as its multiple rerated as investors came to appreciate the cash-generative nature of the business:
|
|
2014E
|
2013
|
2012
|
2011
|
|
Revenue
|
1,400
|
1,407
|
1,655
|
2,070
|
|
Adj EPS
|
3.0
|
3.45
|
4.06
|
6.63
|
|
Price per Share
|
42.9
|
33.4
|
19.3
|
|
|
P/E
|
14.3
|
9.7
|
4.8
|
|
VEC is not as cheap as EGL was coming out of the spinoff, so I don’t anticipate the same degree of outperformance. However, I believe VEC can rerate from a sub-10 P/E to 12-15x, giving a price target of $35-40. Catalysts for rerating are 2015 guidance that will be provided on the Q4 earnings call, additional contract wins, and simple cash generation and debt repayment.
Under-levered balance sheet
Lastly, VEC could support additional leverage. At $100m net debt, VEC is levered ~2x. This will decline over time as cash is generated and the term loan repayment schedule is met. As a comparison, Engility is combining with TASC, a KKR portfolio company, and the pro forma company will be levered over 5x. I don’t expect VEC to be as aggressive as a KKR-backed company, but as VEC wins additional contracts and adds visibility to future cash flow, they will have the ability to juice equity returns through increased leverage.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
2015 guidance given during Q4 earnings
Cash generation & debt paydown
Additional contract wins