Have You Heard Of Cubic Corporation?

| About: Cubic Corporation (CUB)

Summary

New policy regarding critical aspects of the company will lead to gain in efficiency and profitability in 2017.

The shift in the Cubic Mission Support division’s focus to the C4ISR market ensures strategic opportunities to the company.

The transportation division ensures Cubic Corporation long-term growth sales thanks to its expertise in intermodal projects, fare/toll collection and data management.

Quick snapshot:

  • Market Price: $40.50
  • Industry: Defense & Transportation
  • Market Cap:$1.09 B
  • 52-Week Range: $30.11-49.78
  • Beta:1.12

Thesis: BUY

  • Entry point range: $40-40.50
  • Target Price: $49.30
  • Target one-year return: 20-25% range


Source: Bloomberg Click to enlarge

Source: Bloomberg

Business description: Cubic Corporation (NYSE:CUB) develops systems, products and services for the Defense and Transportation industries.

Data from Bloomberg.

Source: Bloomberg

1) New policy regarding critical aspects of the company will lead to gain in efficiency and profitability in 2017.

One Cubic initiative:

One of the five strategic objectives unveiled in the 2020 Goal strategy is the One Cubic initiative. The initiative is a reorganization of the structure of the company. Management envisioned a new corporate culture and structure to facilitate adaptability of the production and technological processes and to decrease inefficiency and ineffectiveness. Cubic Corporation started an update of its information systems in 2015 with the launch of a new enterprise resource planning system. A second deployment of an updated version of the ERP, which includes cash functionalities and program management, is planned in October. The company forecasted to complete its implementation by mid-2017, and it is on budget and schedule for the moment. According to management, investors can expect an improvement in margin within the coming year between 2% and 2.5%.

Restructuring of the Defense division:

Cubic Corporation has reorganized itself into three core divisions: Cubic Global Defense (CGD), Cubic Mission Solutions and Cubic Transportation System. The Cubic Global Defense division was born from the convergence of the Defense Service and Defense System Units in February 2015. This division represented 60% of sales in 2015. The restructuring is still recent even though some signs of improved profitability and efficiency are already visible. Net income margin has increased by 0.4% between 2015 and Q3 2016, and gross margin reached 27.29 in Q3 2016 compared to 22.45 in Q3 2015.

Upper management nominations:

On May 25, the company announced the nomination of the former Navy Vice Adm. David H. Buss as the president of its Global Defense Division. He was the commander of all U.S naval aviation units, or "Air Boss", from October 2012 to January 2015. The "Air Boss" is responsible of the naval aviation training, inspection, operational readiness and administration of all naval aviation units. Buss also served two tours at the Pentagon in the Navy transformation business. Those former responsibilities are in total adequacy with the spectrum of activities (training systems, range design solutions, mission support) of the division and will lead to cutting edge initiatives and to the acquisitions of new contracts. Indeed, on October 4, thanks to his management, the CGD division was awarded with a $5.75 billion multiple award, indefinite delivery, indefinite quantity contract. In addition, Mike Twyman, who is responsible for the new C4ISR (Command, Control, Communications, Computers, Intelligence, Surveillance and Reconnaissance) strategy and oversaw the acquisitions of DTECH, GATR and TeraLogics. He worked in upper management roles for 30 years at Northrop Grumman and represents a decisive asset to the integration of the new acquisitions.

2) The shift in the Cubic Mission Support division's focus to the C4ISR market ensures strategic opportunities to the company.

U.S Department of Defense budget and focus:

In 2015, Cubic made 53.5% of its sales in the United States. Therefore, it is important to analyze the future of the Defense spending in the U.S to understand the environment in which Cubic is evolving.
The U.S military spending will increase from $580 billion in 2016 to $583 billion in 2017 according to the Office of the Under Secretary of Defense. The Defense budget for 2017 also defined new focuses. For instance, the budget includes an allocation of $65 billion FYDP (Future Years Defense Program, which includes current year, budget year and the following four years) to "fund science and technology to further innovation". The Department of Defense wants to "emphasize innovation and lethality and capability of the force rather than size" and wants to expand its focus on the army of the future. With its Next Training initiative, Cubic is well positioned to obtain new contracts. Indeed, the initiative is founded on the enhancement of human skills thanks to virtual training, to constructive gaming solutions and on electronic warfare. On another hand, Cubic has acquired different companies in the last few years to secure business opportunities.

Acquisitions:

In 2014, Cubic acquired DTECH, a company specialized in modular and miniaturized tactical communications products. DTECH started to deliver some of its network on the move products for the Warfighter Information Network-Tactical program of the U.S Army. These products are currently in low-rate initial production, but are expected to pass the test phase and enter full production rate in 2017. In 2015, Cubic concluded the acquisition of GATR, which is specialized in portable satellite communication solutions, and TeraLogics, which produces full-motion streaming video, authentication and video management solutions. Those key acquisitions have led Cubic to enter the C4ISR system market with a strong proposition. Its products are expeditionary and flexible solutions that can be sold as integrated system, stand-alone or within pre-existent systems. There are also compatible with products of competitors. Management expects to create a niche proposition within the C4ISR market solutions, and a study of Research and Markets forecasts the C4ISR market to grow by 3.78% from 2016 to 2020. All those factors and the increased use of Special Operations Forces on the ground are going to lead the CMS division to a sustainable high demand on products with good margins.

C4ISR solutions by Cubic Corporation Click to enlarge

Source: Cubic Corporation

3) The transportation division ensures Cubic Corporation long-term growth sales thanks to its expertise in intermodal projects, fare toll collection and data management:

Source: PwC

Infrastructure Investments:

First of all, it is important to note that the long-term infrastructure gap have increased with the decrease in government spending across the world. This gap will have to be shortened in the next years to come. In the U.S, state and local spending on infrastructure reached a 30-year low in 2014 while U.S spending are projected to be $1.9 trillion short of the $3.3 trillion needed according to the American Society of Civil Engineers. However, decision-makers around the world have taken the measure of the emergency of investing. According to PwC's "Assessing the global transport infrastructure market: Outlook to 2025", investments in transport infrastructure are expected to increase by 5% per year from 2014 to 2025. The three biggest areas of future investment are Asia Pacific, North America and Western Europe, three areas where Cubic Corporation already has ongoing operations. Both American presidential candidates also announced important investment plans. Trump announced a $500 billion infrastructure, financed through new debt, while Clinton proposed a $275 billion plan on direct investment and $275 billion in loans and loan-guarantee programs. While, presidential candidates' promises can be taken with care, Congress passed a $305 billion infrastructure plan in 2015, the largest in more than a decade, showing a renewed interest for this topic.

From Center on Budget and Policy Priorities

Source: Center on Budget and Policy Priorities

Next City strategy:

In February 2016, the Congressional Budget Office also made recommendation regarding the productivity of federal investments for highway infrastructure. The first recommendation of its report was to allow states or private businesses to charge drivers more frequently. Cubic Corporation is an expert in automated fare collection operation, a market that is expected to reach $7.8 billion by 2020. The market in China is forecasted to grow at 19.5% CAGR until 2020, and it could represent an important future growth opportunity for the Cubic Transportation Systems division. However, public investors are looking at new ways of developing infrastructure and are trying to find alternative to building more capacity and gain in efficiency with existing infrastructure. As the urban population keeps growing and number of different transport options exists, the journeys have become more and more intermodal. Cubic has developed a singular solution to answer this trend. This solution, called Next City, is based on its current areas of expertise, open payment system, predictive analytics, traffic management, real-time passenger information, tolling, parking and revenue management. It aims at delivering cities with real-time information about how population moves and why while delivering passengers with travel recommendations and information.

Next City by Cubic Corporation Click to enlarge

Source: Cubic Corporation

CTS Corporation (NYSE:CTS) president, Mr. Matt Cole, as well as Elon Musk (CEO at Tesla (NASDAQ:TSLA)) and Travis Kalanick (CEO at Uber (Private:UBER)), was recently recognized by the ENO Center for Transportation, one the most influential transportation think-tanks, for its efforts to address most present transportation challenges. Cubic is looking at a potential $10 billion market according to management, and the demand for its services and solutions have been growing. New York City, Boston, Seattle, San Francisco, Brisbane have all expressed their interest to Cubic for an upgrade from stored value systems to an open payment system paired up with cloud management. For instance, the company is deploying a pilot solution in Sydney for a potential contract of $100 million. On August 2nd, it earned a $33 million contract upgrade for the Miami Beach transit system. On September 15, it won a $35.5 million contract to deliver the design, development, test and integration of the fare collection system of the future Thomson-East rail line in Singapore. On September 22, Cubic announced the opening of its Global Operations Centre for Operations Services that will deliver 24/7 assistance to its customers while ensuring a centralization of its resources and hence a reduction of its costs. Regarding the reduction of its costs, Cubic has also developed the next generation of its transportation solutions with a code that is reusable from one system to another while improving its cost estimating process with a focus on non-recurring engineering metrics.

Recap:

Cubic Corporation is currently trading at a bargain price. Investors entering the position at these levels are looking at a potential 20-25% one-year return.

  • Entry point range: $40-40.50
  • Price target: $49.30
  • Target one-year return: 20-25% range

Data from Bloomberg.

Source: Bloomberg

Catalysts:

  • Short term (within three months): Stock price fell after announcement of DoD funding delays
  • Mid-term (one to two years): Increase in volume across all divisions, Operating costs reduction, Acquisitions of new contracts
  • Long term (over two years): Infrastructure spending increase, Shift towards Smart city policies across the globe

Risks:

  • Public spending cuts and change in allocation of public spending
  • Incapacity to win new contracts and retain existing ones
  • Lack of innovation in the product offering
  • Ineffectiveness in production management
  • Exchange rate instability, new domestic and international regulations
  • Highly competitive environment

Click to enlarge

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.