SAIC: A 7.5% Special Dividend, A 3.5% Yield, And Limited Sequestration Cuts

With sequestration having been passed, investors may be concerned about companies with heavy exposure to areas such as the Department of Defense. It's logical to believe that defense cuts will materially impact contractors. However, there is one company that believes that the sequestration will have an immaterial impact. It is also putting money where its mouth is by distributing more capital to shareholders.

SAIC (SAI), which provides IT and engineering services to the DoD and other federal agencies, has announced a $1 special dividend to be distributed in June to all common shareholders. The special dividend has a yield of 7.5% at current market prices. This is a nice distribution for shareholders, and should ease concerns about sequestration. Management is signaling that even with budget cuts, the company will be fine.

Even sequestration, management has mentioned that backlog has not changed at all. The company ended the quarter with $17.9 billion in backlog, and has already received $5.4 billion of it. There has been no reduction in backlog so far with the budget cuts.

SAIC has already submitted bids on $24 billion worth of contracts. During Q4, the company won 8 contracts with more than a $100 million each. This does not include the $1 billion in classified intelligence programs.

So as we can see, budget cuts have not really made any dent for SAIC. FY 2014 EPS is expected to be $1.16-$1.33. The range is larger since management is being cautious about the $42.5 billion in defense cuts. However, I do believe that the company is likely to earn above $1.25 per share given the current backlog and the new bids that went out.

As for free cash flow going forward, cash flow from operations is expected to be $450 million for FY 2014. CapEx is only going to be 1% of operating cash flow. Therefore, free cash flow will remain well above $400 million. This is more than enough to cover the regular dividend of $164 million. The payout ratio to free cash flow is 41%, which is fairly reasonable.

The current regular dividend yield is about 3.5% and given that the company is issuing a 7.5% special dividend, shareholders are going to be very happy about this. Management is sending a clear message to the market and shareholders with this special dividend that sequestration is not going to have any material impact to cash flow.

The special dividend may be a sign that a dividend increase is likely to happen as well. With so much uncertainty with the federal defense budget, shareholders should take this as a strong indicator for the company's commitment. While management has mentioned that they don't expect any impact from sequestration, investors should keep in mind that the government is still running a huge deficit. Cuts will continue to happen going forward, but for now, it seems SAIC has been bidding on vital programs for the government.

Investors looking for some nice distributions should consider purchasing SAIC. The special dividend is going to be issued in June and getting in now will help investors lock it in. Once the special dividend is distributed, investors should hold on, as the common will continue to pay a 3.5% dividend and given its payout ratio, that could rise above 4%.

Disclosure: I 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.