KBR: Potential Upside For Revenue And Profitability Growth

Jun. 07, 2022 4:14 PM ETKBR, Inc. (KBR)
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Summary

  • The current geopolitical situation is helping KBR’s business.
  • The increase in this year’s defense budget compared to the previous year should also be beneficial for the company.
  • Profitability should continue to improve as the company exits its lower-margin business and focus on higher-margin work.

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Investment Thesis

The current conflict between Russia and Ukraine has resulted in increased activity across KBR's (NYSE:KBR) defense and Intel business during the quarter. As a result of this conflict, in addition to the U.S., other countries too are prioritizing investment in military forces and national security. In March 2022, the U.S. government signed the Omnibus appropriation law under which $782 bn in spending was authorized for defense (up 6% Y/Y) whereas $24 bn was authorized for NASA (up 3% Y/Y). This should act as a tailwind for KBR in building its order pipeline and strengthening its backlog orders.

Last Quarter Earnings

KBR reported mixed results for the first quarter of 2022 compared to consensus estimates, but excellent year-over-year growth. Revenue increased 17% year over year to $1.71 billion, almost in line with the consensus estimate of $1.72 billion. The adjusted EPS increased by 29% year over year, from $0.48 to $0.62 (versus the consensus estimate of $0.57). The increase in revenue was driven by 25% Y/Y growth in the Government Service ('GS') business segment with 21% organic growth, including a contribution of $269 mn from the OAW (Operation Allies Welcome) program. The acquisition of Frazer-Nash in October 2021 accounted for the rest of the growth. This growth was partially offset by a 14% Y/Y decline in the Sustainable Technology Solutions ('STS') segment due to the exit of commercial activities in Russia and the exit from commoditized services which was announced in 2020. The adjusted EBITDA margin dropped 20 bps from 9.2% in Q1 2021 to 9% in Q1 2022. The increase in revenue coupled with modest Y/Y improvements in FX, and interest and taxes led to the growth in adjusted EPS.

KBR's Growth Drivers

Bookings in the first quarter of 2022 totaled $1.2 billion, excluding the recompete GSMO award from NASA, which is expected to be booked in the second quarter. During the quarter, the total backlog and options were $18.1 billion, with $16.1 billion from the Government Service ('GS') segment and $2.4 billion from Sustainable Technology Solutions ('STS'). For the GS business, almost 90% of the management's revenue guidance for FY22 is already secured in the backlog at the end of the last quarter giving good visibility on this year's earnings. Despite the exit from the Russian market, the book-to-bill ratio for STS business was 1.3x. The book-to-bill ratio in the quarter was 1.4x, excluding the de-booking of Russian work.

In March, the US government signed the Omnibus Appropriations Bill, which included $782 billion for defense spending (up 6% year over year) and $24 billion for NASA (up 3%). Internationally, the United Kingdom, Australia, and other allied governments are also prioritizing national security, cyber, and military space superiority as a result of the Russia-Ukraine conflict. So, the ongoing situation with Russia is benefitting KBR's Defense & Intelligence business. The budget funding, combined with current geopolitical tensions, provides an opportunity for KBR to strengthen its order pipeline and support the GS business's future revenue growth. Aside from that, KBR's acquisition of Frazer-Nash in October 2021 has been fully integrated into the company's operations. In Q1 2022, Frazer-Nash in Australia was the main driver of the International business's 24% Y/Y growth.

Given rising oil and gas prices, as well as the need to build additional production capacity for commodities, including ammonia, clean refining products, olefins, and petrochemicals, the outlook for Sustainable Technology also appears bright. The big oil companies are moving toward decarbonizing their assets and diversifying their portfolio as a result of environmental pressure and the climate change agenda, which is good for the STS business. Companies with aging assets are also looking forward to decarbonizing and increasing plant efficiency, which presents opportunities for companies like KBR.

Overall, the company's backlog and order pipeline appear to be healthy and the company has good visibility with 85% of FY22 revenue guidance already secured in the backlog. Both business segments have a bright future outlook, which should support the company's revenue growth in the long term. The revenue guidance for fiscal 2022 is in the range of $6.3 bn to $6.8 bn, up 14% Y/Y at the midpoint excluding a $1.6 bn benefit from the low margin OAW project in 2021. Last year KBR won the project award to assist DoD in the OAW (Operation Allies Welcome) program and had to provide humanitarian support to the refugees from Afghanistan. However, the company is winding down this project, reducing the total revenue in 2022. The current consensus estimates are at $6.64 bn in revenues and I believe the company can easily meet this guidance.

Margin Outlook

Due to higher sales volume, the Government Services segment's adjusted EBITDA margin increased 90 basis points Y/Y to 9.8% in Q1 2022. Due to lower sales volume during the quarter and the exit from Russia, Sustainable Technology Solutions' segment EBITDA margins fell 50 basis points to 16%. The STS segment benefited from the closeout of a business in the first quarter of the previous year, which boosted the segment's margin last year. So, the comparables were slightly difficult this year. KBR's results are consistent with the company's transformation plan that it had set out for the STS business 1.5 years ago. KBR is transforming itself by prioritizing to derisk its business by exiting commoditized energy business and shifting towards higher-margin technology-led solutions business.

Both businesses are experiencing strong demand, which is causing the company's revenue to grow, and the company's profitability is improving due to the transformation in the company's business portfolio. The OAW project which was of a lower margin and was dilutive to the GS segment margins is almost complete now. Given the increase in revenue from backlog conversion and with the ramp down of the low margin OAW work, the company expects adjusted EBITDA margins of 10% for the full year of 2022 vs. 8.5% last year.

Valuation & Conclusion

KBR is currently trading at 19.44x FY22 consensus EPS and 16.08x FY23 consensus EPS. The increased funding for Defense and NASA should be beneficial for the company along with the ongoing conflict between Russia and Ukraine. The move toward ESG by big companies should create growth opportunities for the company. The solid growth prospects and margin improvement initiatives by the management along with attractive valuations make KBR a good buy.

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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

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