Shares of certified rocket scientist and Motley Fool Rule Breakers pick Orbital Sciences (NYSE: ORB ) have remained flat since the earnings announcement. This is good, considering that the S&P 500 is down 5%. Orbital report exceeded expectations in some area, matched them in others, and the overall picture ends up looking mighty fine.
Before we get to why, here's the raw data for you:
- Q3 sales of $278.6 million were up 1% -- considerably better than Wall Street's expected 4% decline
- Free cash flow did even better -- up 66% year over year to $37.1 million, which was more than Orbital had earned in the first two quarters of this year combined.
- Earnings under GAAP, meanwhile, were right on target at $0.20 per share.
Now, that last number may not sound so hot. It is, admittedly, down 23% year over year. Still, this was to be expected. Orbital is spending hand over fist to develop a new medium-lift rocket called the Taurus II, which it hopes will fill a slice of the nation's rocket-launching needs. And if Boeing's (NYSE: BA ) Delta II rockets are ever retired, the Taurus' chances of success will only increase. While Orbital expects the Taurus to generate significant new, profitable revenue eventually, for now, developing the thing is going to cost 'em.
Um, how much?
Considerably. Thanks in large part to surging R&D costs, Orbital's operating margin for the first nine months of this year is only 7.8%, pushing it ever farther behind peers like Northrop Grumman (NYSE: NOC ) and Lockheed Martin (NYSE: LMT ) . That margin is expected to fall further still by year-end, landing at about 7.5%. And next year, revenues that continue to grow will come to loggerheads with a still-falling profit margin. The result, as Orbital advised us last week, will be something on the order of a 6% operating margin in 2009, a double-digit slide in per-share profits, and flat to declining free cash flow.
Yeah, I know. Hardly the kind of news you expect out of a "growth stock." But here's the thing. Orbital thinks that if it can get the Taurus II program up and running quickly enough to steal market share, it could rake in as much as $300 million in annual revenue from this program alone. That's 25% of Orbital's annual take today, and it would come with "above company average margins."
The opportunity to steal a march on its rivals and capture this lucrative business for the long-term is, in Orbital's view, worth a bit of margin compression today. And seeing as management seems capable of capturing it with what is, in the larger scheme of things, really minimal investment, and without hurting free cash flow all that much, I can't help but agree.
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