When Orbital Sciences Corp. Warns, Orbital Sciences Stock Burns

But sometimes, a lower stock price is just a cheaper price you have to pay to own a great company.

Jul 18, 2014 at 1:01PM

Yesterday was not a fun day to own Orbital Sciences (NYSE:OA) stock.

Orbital
Like this Antares rocket, Orbital's not firing on all jets right now -- but it could be soon. Photo: Wikimedia Commons

That's actually strange, when you think about it. After all, reporting on its fiscal Q2 results Thursday, Orbital Sciences was able to boast of a $0.05 "earnings beat" over analyst estimates. Its merger plans with new partner ATK (NYSE:ATK) -- a combination roundly praised on Wall Street -- appears to be on track for completion by year-end as well. So... what was it, exactly, that investors didn't like about yesterday's news?

Let us count the ways.

In Q2 2014, Orbital Sciences reported:

  • Revenues of $318 million, down 4.5% against Q2 2013, and 11% below consensus estimates.
  • Higher input costs, and rising expenses for selling, general, and administrative costs (probably inflated by the costs attendant on getting the merger done).
  • Less investment in research and development.
  • And lower operating profit margins of 4.8% on these revenues (down more than 300 basis points versus last year's Q2 profit margin).

On the bottom line, profits of $16.5 million were apparently better than what Wall Street expected. Nonetheless, they were basically flat against last year's Q2.

Meanwhile -- and one suspects this is the factor that really spooked the market, and that cost Orbital Sciences stock 4.4% of its market cap yesterday -- the company warned that revenues for the remainder of 2014 will come in lighter than previously hoped (perhaps as low as $1.4 billion by year's end). As a result, despite earning $0.05 more per share than it was "supposed" to earn in Q2, the company held firm on earnings guidance for the full year -- implying that whatever extra profits Orbital accumulated in Q2, they will dissipate in the second half of the year.

So is Orbital a sell?
No, Orbital Sciences stock is not a sell. And I'll tell you why not.

Basically, it comes down to valuation -- and prospects. Valuing the stock as a stand-alone entity, which I'll continue to do until the merger happens, I see Orbital selling today for about 27 times earnings, and pegged for 13.5% long-term earnings growth on Wall Street (according to S&P Capital IQ estimates). That looks expensive, but really isn't.

The reason: Orbital generates just gobs of free cash flow from its business -- $138 million over the past year, which is more than twice its reported earnings as calculated under GAAP. This gives the stock an enterprise value to free cash flow ratio of just 10.5, which seems to me a very attractive valuation on 13.5% growth.

Meanwhile, growth prospects appear to be something Orbital has in spades. Last quarter, the company recorded some $435 million in new firm and option contract bookings, plus an additional $115 million in option exercises from its customers on existing contracts -- $550 million in total. That's more than 40% of the revenues that Orbital collected in all of last year, and the company booked added them to its backlog in just 25% of a year's time. As a result, the company now has total backlog of approximately $4.8 billion on the books, enough business waiting to be done to keep the company busy for the next three-and-a-half years, at the current revenue run rate.

Long story short, while Orbital's revenue and profit margins decline in Q2 was disconcerting, one quarter does not a stock make (or break). Orbital's future looks bright, and after yesterday's sell-off, I think Orbital Sciences stock is bargain priced.

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Rich Smith has no position in any stocks mentioned. The Motley Fool recommends Orbital Sciences. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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