Alliant Techsystems provides an intriguing opportunity for mid cap value investors. Due to anticipated budget cuts in government spending, analysts and industry experts are predicting sluggish growth in the Aerospace and Defense industry. The market has reacted appropriately, as most companies in the industry have low levels of growth priced into their valuations (assuming a cost capital between 9-10%). This is a strong indicator that Wall Street has estimated that industry demand has peaked.
ATK’s stock has been hit particularly hard, shedding almost 25% of its value over the past twelve months. Despite stagnant demand, ATK has demonstrated consistently good earnings, beating analyst estimates 8 straight quarters. ATK also produced $12.8 Cash Flow from Operations per share, and $4.27 Free Cash Flow per share last year.
Interestingly, ATK’s Security and Sporting division reported a 28% growth in revenues (with 15% being organic) in their 2011 Annual Report. While this still represents a minority portion of total sales (less than twenty percent), it’s worth noting that this business segment is experiencing robust growth, and is not reliant on government spending. ATK’s Armament Systems division has also produced strong sales growth primarily due to high demand for small caliber and non-standard ammunitions. Their Armament division as a whole made up roughly 37% of total sales, and relies heavily on government contracts.
ATK also has Missile and Aerospace divisions that are heavily reliant on government contracts. Missile Systems division has experienced relatively flat growth, while the Aerospace division faces headwinds with NASA and other government spending cuts.
The table below compares five similar companies to ATK. It’s important to note that while ATK is significantly smaller than their competitors, competitive advantage is still obtained by improving and developing new products through research and development. ATK is still susceptible to the same risks as their competitors, as they are all substantially influenced by the U.S. Department of Defense budget.
Using adjusted GAAP EPS (trailing 12 mo.) as a value generator, relative valuation shows significant upside to ATK:
Note that ATK’s operating margin, at 11.62%, is about the same as the average operating margin of the five competitors. This further cements the case that ATK has the ability to maintain the same profitability levels as their larger counterparts (and could potentially make a great acquisition target).
ATK’s Price/CF ratio also shows that the company may be significantly undervalued. Based on conservative assumptions (low growth priced in), I’ve calculated an intrinsic value per share around $70-$80 using various discounted cash flow models.
It’s important to note that while the demand for the Aerospace and Defense industry may have already peaked, it will still be a huge multi-billion dollar industry in the foreseeable future. Even with little to no growth priced in, ATK’s current stock price shows significant upside for value investors who aren’t afraid to buy on fear.