It’s clear the defense-spending environment isn’t exactly rosy but CACI International (CACI) is an interesting name. The firm is an industry leader in the U.S. government IT service and support space. We feel that CACI has navigated the rough economic waters well, holds a valuable relationship with the government that spans over three decades, and most importantly still has solid growth potential moving forward.
The firm has benefited greatly from the government upgrades in IT and infrastructure since 9/11. In particular, CACI has positioned itself as a strong asset to the U.S. by taking on extensive exposure in the intelligence space. Thus even with a hot topic such as the U.S. budget deficit the firm still looks to be more insulated from potential cuts on various projects.
Many of the firm’s employees already hold the necessary security clearances to work on sensitive projects with various agencies and this has allowed it to develop an extensive government network. This strong network matters because it helps the firm find more cross selling points. As well, the firm recently won two new awards for modernizing certain FBI and DOJ IT systems. In our view CACI holds competitive advantages that relate to its extensive relationships, properly qualified personnel, and familiarity with current systems. These key points have helped it win new contracts.
A good portion of the CACI business model deals with recurring revenue. This stems from the fact that the services provided are on multi-year contracts, Further, it’s expected that it will retain these contracts when the renewal arises. This natural barrier to entry only provides the firm with another advantage.
By no means is this firm perfect. One concern relates to its most recent book/bill ratio of .8, which is less than 1.0. It is a bearable number though given that in the nine months prior the firm pulled in $2.7B. This brings its book/bill number up to 1.04. In our view this provides a passing grade for now.
Another concern relates to the firm's slipping operating margin. It is currently at 6.56% (TTM). It’s not great and we expect it to stabilize. Most recently, the firm reported revenue growth (YOY) of 16.5%. We find this to be a strong indicator of future potential despite its shortcomings.
Risks and Head Winds
The firm’s business model and platform is built to primarily serve U.S. government needs. The greatest single risk to the firm would be the implementation of substantial austerity measures in relation to budget deficit issues. This includes cutting back operations abroad in theaters of combat such as Afghanistan and Iraq. Should some of CACI’s projects be targeted this could materially impact the firm.
Valuation and Modeling Method
We are rating CACI as an overall BUY. In our proprietary DCF model we priced the firm’s fair value to be $78. The trading price is $60.10 (06/11/2011). Currently, we are more bullish on this particular company than the overall U.S. economy.
When reviewing price multiples such as Price/Book, Price/Sales, forward PE and the Price/CFO ratio we saw it to be undervalued relative to the S&P 500 (SPY). Below we provided bearish, neutral and bullish scenarios with respective price points:
In a bear scenario we forecast a decrease in revenue growth, deterioration in operating margins, and a higher discount rate (WACC). We would expect the global economy as a whole to contract. The price target came out to be $45.
We fall into the neutral camp even as we rate the firm a BUY. Here we expect to see moderate double-digit revenue growth, no deterioration in the capital structure, and stable margins. Our view on global economic growth is slow. The fair value estimate is $78.
In an amazing situation the firm’s capital structure and margins would improve. As well, we would expect to see mid-double digit revenue growth and the U.S. deficit to improve without heavy spending cuts. The price projection here is $95 but we find this to be a low probability scenario.
1. At this point we feel the firm has built a narrow economic moat and that this insulates the firm from budgetary concerns on some level.
2. The firm benefits from recurring revenue contracts, which should translate into more stable cash flow over the long term.
3. The firm has a significant business relationship with the U.S. government and years of experience with them. This experience would be difficult if not impossible to replicate in a short period of time by a competitor.
Management and Stewardship
J.P. London, chairman of the board, has been with the firm since the 1970s and has been an instrumental force. The board as a whole is comprised of 10 members and the majority are independent. We like the fact that a significant portion of board compensation is equity. Overall, we feel the firm has implemented sufficient incentives to keep board members aligned with the interests of shareholders.
Financial Health and Analysis
In our view CACI’s financial health is average. We would like to see the firm’s quick ratio to be higher and/or moving in an upward trajectory given its short-term obligations. Regardless, we feel that the firm generates sufficient cash flow to manage its debt obligations without issue.
The firm at this point does not pay a dividend and we find this to be preferable. The reason relates to the fact that as the firm continues to grow it makes acquisitions and we don’t want the firm to become financially stretched or forced to pass up a sound opportunity because of financial constraints.