VSE Corporation (VSEC) recently reported the results for its third quarter of 2008. Revenue grew 76%, net income grew 58%, and diluted earnings per share grew 58%. For the nine month period ending September 30, 2008, revenue grew 64%, net income grew 42%, and diluted earnings per share grew 38%. As of September 30, 2008, funded backlog was 706M, up 73% from 408M at December 31, 2007.

The company has a market cap of 145.4M corresponding to a stock price of 28.62 and has generated 10.3M in owner earnings for the first three quarters of this year which implies a run rate of 13.7M for the year. With 1.1M in cash and no debt, the company has an enterprise value of 144.3M and therefore is trading at an EV/OE multiple of 10.5. A DCF calculation based on a 5-year growth period, 3% terminal growth, and an 11% discount rate shows that the current price reflects an assumption of no growth.

In the earnings release for the second quarter of 2008, Edward Fred, President and CEO of CPI Aerostructures (CVU), provided revenue and net income guidance for 2008 as well as a long-term outlook for 2009 through 2011 (see conference call transcript). The company has just announced its earnings for the third quarter, and so we can look to see if it is on track toward achieving its projected results.

Revenue in 2006 was 17.9M and this grew to 28M in 2007. The first half of 2008 produced revenue of 16.9M and, in the second quarter conference call, Fred projected 2008 revenue of 35M. The latest earnings release shows that revenue for the third quarter came in at 9.4M, a 30% increase over the year-ago quarter, and that, for the first nine months of 2008, revenue was 26.4M, a 30% increase over the corresponding period in 2007. Fred reaffirmed his revenue guidance of 35M for 2008 noting that this represents a 25% increase over 2007.

I recently reviewed the second quarter results and offered valuations for three small defense contractors: ManTech International  (MANT), VSE Corporation  (VSEC), and CPI Aerostructures (CVU).

The valuation approach I have taken is based on owner earnings, which is a variation on free cash flow. Basically, owner earnings is free cash flow with working capital removed from consideration. It is computed as net income plus depreciation and amortization minus capital expenditures, and adjusted for one-time items if necessary. An argument could be made for only subtracting off the portion of capex required for maintenance, thereby including growth capex in owner earnings. However, I generally take the more conservative approach and subtract out total capex.

It’s been a quite while since I took an initial look at ManTech International Corporation (MANT). Back in April 2007, the stock was trading at 33.27. It now stands at 59.29, a 78% increase. It’s time to look at how the company has performed during this period to ascertain whether or not this price appreciation is justified and, if so, whether the current price represents a good buying point.

As of April 2007, the company had forecast 2007 earnings from continuing operations between 1.76 and 1.84 per share on revenue between 1.26B and 1.3B. These estimates were nicely exceeded with 2007 earnings from continuing operations of 1.95 on actual revenue of 1.45B. This represents 19% growth in EPS and 27% growth in revenue over the 2006 figures. Net income from continuing operations grew 21%. With regard revenue growth, it is important to note that organic revenue growth (non-acquisition related) was 16%. The three-year period ending December 31, 2007 saw an organic growth rate which averaged 14%.

I have been following micro cap defense contractor VSE Corporation (VSEC) closely and continue to be impressed with its growth trajectory. Here is some general background based on the results from its second quarter, and my most recent thoughts on its valuation can be found here. I have recently come across another promising defense contractor, CPI Aerostructures (CVU). By any standard, this is a small company. Its market cap is only $42M (which makes it small even compared to VSE whose market cap is $192M), but it seems poised to emulate the success which VSE currently enjoys.

CPI Aero produces structural aircraft parts for the U.S. Air Force, other branches of the armed forces, and leading defense contractors. It supplies such programs as the C-5A cargo jet, the T-38 Talon jet, the A-10 Thunderbolt attack jet, the E-3 Sentry AWACS jet, the UH-60 Black Hawk helicopter, the Sikorsky S-92 helicopter, the Gulfstream G650, and others.

In my recent valuation of VSE Corporation (VSEC), I suggested waiting for the price, which is currently around $40, to pull back to the range $33-$35.

However, I have decided to pick up a few more shares at the current price based on what I believe to be a better valuation than previously discussed.

In a recent article, we noted that VSE Corporation (VSEC) has been growing nicely over the last 5 years. On an annualized basis, revenue growth is 49%, net income growth is 63%, and diluted EPS growth is 58%. It is instructive to examine the company's funded backlog. As noted in the company's Form 10-K, the "funded backlog for government contracts represents a measure of the Company's potential future revenues and is defined as the total value of contracts that has been appropriated and funded by the procuring agencies, less the amount of revenues that have already been recognized on such contracts." Funded backlog grew from 83M in 2003 to 408M in 2007.

This is a low-margin business due to very high contract costs. In 2005, 2006, and 2007 gross margins were 3.7%, 3.5%, and 3.6%, respectively, operating margins were 3.6%, 3.4%, and 3.5%, respectively, and net margins were 2.2%, 2.1%, and 2.2%, respectively.

Let’s first take a quick look at how VSE Corp. (VSEC) has been doing over the last 5 years and then look at the results of the first quarter of 2008.

I have been teaching in a traditional college or university setting for almost three decades, and, while much of my teaching has been directed toward traditional-age students, I have over the years regularly taught adult students, and more and more of my energies have been devoted to this population in recent years. Even though many college and university administrators seem oblivious to the increasing market share of adult students being garnered by the for-profit sector, no serious observer of degree programs for working adults can deny the profound impact which the for-profits are having in this area. From an investing perspective, I am mindful of Peter Lynch's maxim, "Buy what you know," and so I am always on the lookout for promising companies among the group of for-profit universities. My most recent discovery in this regard is Capella Education (CPLA).

There is much evidence to support the claim that online courses are becoming an increasingly important part of the overall mix of courses being offered at degree-granting institutions. Indeed, Eduventures, an education research and consulting firm, estimates that by 2008, the number of online students will reach approximately 2.1 million and that this figure will represent about 12% of all degree-seeking students.

VSE Corporation (VSEC) reported its third quarter 2007 results on October 31. Unfortunately, the press release did not contain a balance sheet or cash flow statement. The 10Q has just been posted on the SEC web site and so we can now take a look at where things stand.

Revenue increased 69%, net income increased 78%, and diluted EPS increased 69%. The diluted share count grew 4.6%. Owner earnings, (defined as net income + D&A – capex) for the nine months ended September 30, 2007 grew 74% over the figure for the year-ago period. The balance sheet shows cash of 7.6M and no debt.

Nathan's Famous (NATH) has just reported second quarter results from its 2008 fiscal year. Revenue from continuing operations grew 12.2%, net income from continuing operations grew 20.1%, and diluted EPS from continuing operations grew 12.5%.

My previous valuations of the company have tended to show that the stock has generally been priced at a level which reflects an assumption of little or no future growth. To see if this is still the case, we note that the price currently stands at 16.69 and the market cap is 103M. With cash and marketable securities totaling 31.7M and no debt, the company sports an enterprise value of 71.3M. With TTM revenue of 48.4M, we have an enterprise-value-to-revenue ratio of 1.5. With TTM diluted EPS (from continuing operations) of .88, we have a PE of 19.

I have spent my entire professional life in a traditional academic setting where I have taught traditional-age students for the better part of 25 years. I am a product of, and am deeply ingrained in, the concept of the private nonprofit college and university. The American higher education system is the envy of the world, and those students who, immediately upon graduating high school, are fortunate enough to be able to attend a four-year institution on a full time basis and reside on campus reap enormous long-term benefits, both material and otherwise, from the experience.

It is of course a fact of life that not everyone is so fortunate. Many enter the work force immediately after high school or perhaps begin college but for a variety of reasons are unable to complete their degree. At some point in their lives, many of these people recognize the need to complete their education, and we see at present vast numbers of non-traditional students, i.e., working adults, enrolled in a variety of institutions and working toward their degree.

2005: 14% revenue growth
2006: 20% revenue growth
2007: 11% revenue growth

Net income from continuing operations grew 16.5%.  This, too, is weaker:

For a while now I have been looking to see if there are any other players in the sector that share some of Strayer’s strengths and prospects. As I wrote recently, I think I may have found one in Capella Education (CPLA).

The current market cap is 245.4M corresponding to a stock price of 50.48.  Cash on the balance sheet has decreased due to the acquisition of ICRC, but the company still has no debt.  With an enterprise value of 244.1M and TTM revenue of 485.9M, the enterprise-value-to-revenue ratio stands at .5.  Diluted EPS (on a TTM basis) is 2.16, giving the stock a PE of 23.

The stock stands at 158.31, having risen 15% following the earnings announcement. On a trailing twelve month basis, diluted EPS is 4.05 giving a PE of 39 and a PEG of approximately 2.1. The market cap is 2.3B and the enterprise value is 2.13B. On a TTM basis, revenue stands at 290.1M giving an enterprise-value-to-revenue ratio of 7. Owner earnings (defined as net income plus depreciation and amortization minus maintenance capex) is 58.5M on a TTM basis giving an enterprise-value-to-owner-earnings ratio of 36 and (EV/OE)/G = 1.9. Certainly, if one considers only these ratios, the stock looks very expensive.

Enrollment trends are strong. Total enrollment increased 19%, continuing student enrollments increased 20%, and new student enrollments increased 16%. These results show that Strayer is doing an excellent job of both retaining existing students and attracting new ones. This combination of solid results in both retention and recruitment is perhaps the most important fact in the report.

A particularly attractive feature of Strayer’s operation is the range of delivery options it offers students. In addition to traditional campus-based instruction, the company has a highly developed on-line delivery system offering courses in both synchronous and asynchronous formats. The company continues to see increasing demand for its online courses. Out of area online students (those students who are not located near a physical campus) increased 19%, students taking 100% of their classes online increased 21%, and students taking at least one class online increased 22%.

In early June, I ran a valuation of VSEC. In light of the significant price appreciation which has occurred even since then, it's time to update the analysis.

The share price currently stands at 53.55. The company sports a market cap of 260.4M and an enterprise value of 243.7M. With TTM revenue of 480.1M, we have an enterprise value to revenue ratio of .5. Owner earnings, defined as net income plus depreciation and amortization minus capital expenditures, stands at 10M on a TTM basis. This gives an enterprise value to owner earnings ratio of 24.

The one disappointment in these results is a smaller-than-hoped-for increase in operating margins. Operating margins increased to 9.2% (versus 8.4%) for the quarter and to 9% (versus 7.4%) for the year. The company fell short of its goal to reach an operating margin of 10% in 2007. The company did say that it is on track toward a 10% operating margin for 2008 and still expects to achieve its longer-term goal of a 12.5% operating margin within the next three years.

The balance sheet shows cash of 83.3M, down from 121.7M a year ago. Long term debt stands at 327.9M, up from 320.9M a year ago. Stockholders’ equity is 494.2M, up from 422.7M a year ago.

As I have written before, I am convinced that the future of degree programs for working adults lies in the for-profit sector and I continue to feel that Strayer is an extremely attractive player in that sector. Its attractiveness is due to the company’s stellar fundamentals, its nearly flawless execution, and the fact that it has never been implicated in any of the misdeeds which plague the education sector.