Parsons: Investor Day Highlights The Case For A Narrowing Valuation Discount
Summary
- Parsons delivered a robust set of medium-term targets at its inaugural investor day.
- I see room for upside, however, as the current projections seem fairly conservative.
- With the company also set to benefit from secular tailwinds across IoT and environmental remediation, along with M&A-led optionality, the current relative valuation discount seems unwarranted.
Parsons (NYSE:PSN) recently hosted its inaugural investor day event, which outlined key longer-term shifts in the business model and strategic priorities, along with secular growth drivers as the company looks to achieve its fiscal 2023 targets. The key positive was the impressive top- and bottom-line guidance across both major business segments, backed by the vast opportunity pipeline. Yet, the fact that the guidance does not include M&A contributions or embed any upside from an upcoming infrastructure bill likely implies conservatism in the estimates. Considering Parsons' demonstrated track record of servicing government customers as well as the growth and margin expansion potential, the current valuation discount to peers seems unjustified and should narrow over time.
Strong Revenue Growth Outlook Supported by Expanding Pipeline
Encouragingly, PSN's initial outlook for fiscal 2023 revenue targets and strategic objectives were upbeat, with a 5-7% organic revenue CAGR targeted, in addition to a 3-5% M&A-led CAGR. Key to the growth outlook is PSN's significant pipeline, which has doubled from the start of fiscal 2020 with the number of submitted bids in fiscal 2021 on track to total $24.9 billion (vs fiscal 2020's bid level of $12.4 billion). I still see plenty of room for growth, however, considering PSN operates in fast-growing markets, with an aggregate addressable market of ~$110 billion (comprising c. $73 billion on the Federal Solutions segment and c. $37 billion on the Cyber & Intelligence side).
Source: Parsons Investor Day Presentation Slides
Stronger CI Outlook Driven by Secular Tailwinds
Interestingly, PSN provided a revenue bridge to the midpoint of its upgraded fiscal 2023 target of $2.3 billion for CI ("Cyber & Intelligence"). While program transitions and completions are set to be a $700 million headwind, this will be more than offset by c. $1.0 billion of total organic growth, of which c. $600 million will come from Mobility Solutions and c. $400 million from Connected Communities. Much of the growth will be derived from secular trends such as replacement demand for aging transportation and general infrastructure, as consumers increasingly move toward smart cities and IoT-driven solutions.
Source: Parsons Investor Day Presentation Slides
In addition to the range of opportunities at hand, environmental remediation could drive incremental upside as well, considering the Biden Administration's focus on the theme. The size of the PFAS ("poly- and perfluoroalkyl substances") remediation opportunity is significant - PSN believes environmental remediation represents an addressable market of over $700 million/year. Another significant driver could be a potential infrastructure bill from the US government, which would imply incremental upside to the current segmental targets.
Source: Parsons Investor Day Presentation Slides
Conservative Margin Outlook Leaves Room for Upside
PSN also provided a preliminary fiscal 2023 adj EBITDA margin target of 9.3% at the midpoint, which was somewhat disappointingly just below the company's near-term c. 10% adj EBITDA margin target. Nonetheless, I view this outlook as fairly conservative, especially considering PSN is in the midst of a transition into a more margin accretive, transaction-oriented revenue stream.
Source: Parsons Investor Day Presentation Slides
With margins of over 20% likely on the back of increased standardization and technical solutions, a further transition should drive higher margins going forward. Another key margin lever is recent acquisition Braxton - as Braxton currently has only sub-10% of revenue from transactional-type contracts (similar to PSN), further expansion here should be accretive to margins as well. In addition, I would note that future M&A optionality has not been included in the outlook, leaving room for an upside surprise considering its acquisitions have generally carried a 10+% EBITDA margin profile.
M&A Remains the Key Driver of Capital Allocation
Looking ahead, organic growth should continue to be supplemented by acquisitions in core technologies within AI, autonomous, cloud computing, and IoT, with the most recent one being the $300 million all-cash acquisition of Braxton Science & Technology Group. Considering the prior success, M&A should continue to be a key growth driver - for instance, revenue synergies from OG Systems and Polaris Alpha are already contributing to bids and jointly winning contracts alongside the legacy business. As a result, management projects a robust pipeline and active M&A ahead, with the target currently for 1-2 bolt-on transactions per year. Also notable is the fact that management is maintaining M&A discipline - PSN's criteria remains for 10+% organic growth 10+% margin companies, with an emphasis on products and solutions.
Source: Parsons Investor Day Presentation Slides
Cash generation should remain strong as well - PSN targets converting over 100% of net income to free cash flow (down from the c. 120% conversion in fiscal 2020). At the midpoint, this implies FCF could grow at a steady 7% CAGR, which should drive over $300 million in FCF by fiscal 2023. The company will also be supported by a relatively clean balance sheet. With management comfortable with maintaining 2-2.5x net leverage (net debt to EBITDA was 0.3x at end-2020), this leaves plenty of flexibility with regard to dry powder as well.
Final Take
Overall, Parsons delivered a solid investor day, making the case for its unique positioning and strategy underpinning continued longer-term growth. With the current targets appearing fairly conservative, I see plenty of upside in the shares as the company executes on its strategic plan, with further room for an upside surprise from capital deployment (mainly M&A-related). Yet, shares trade at a relative discount to peers like Booz Allen (BAH), Raytheon Technologies (RTX), AECOM (ACM), and Jacobs (J) on an EV/EBITDA basis, which seems unjustified considering its growth and margin expansion potential. As such, I believe a re-rating of the shares is warranted, with the discount likely to narrow as the company proves out the investment case.
This article was written by
Analyst’s 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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Seeking Alpha's Disclosure: Past performance is no guarantee of future results. No recommendation or advice is being given as to whether any investment is suitable for a particular investor. Any views or opinions expressed above may not reflect those of Seeking Alpha as a whole. Seeking Alpha is not a licensed securities dealer, broker or US investment adviser or investment bank. Our analysts are third party authors that include both professional investors and individual investors who may not be licensed or certified by any institute or regulatory body.