Shares of defense contractor Cubic Corporation (CUB +0.00%) shed 11% of their market capitalization earlier this week after the company reported earnings that broadly underwhelmed the market.
For fiscal Q2, Cubic reported:
- Quarterly sales down 6% to $343.7 million.
- Operating costs down even more -- 8%.
- But not down enough to yield an operating profit. Instead, Cubic scored an operating loss of $2 million.
Even with a big $7 million tax benefit boosting bottom-line results, this resulted in net profits falling 95% year over year, to just $0.02 per share.
Cubic Corporation is a leader in military training. Image source: Cubic Corporation.
Cubic's three divisions
All three of Cubic's main business divisions experienced declining sales in the quarter, with transportation systems (the company's biggest business) seeing a 6% decline in sales, global defense systems (second biggest) dropping 7%, and sales at the small global defense services unit down 5%. Profits declined by more than half at transportation and defense services. On the plus side, defense systems, although it lost money for the quarter ($4.4 million), at least lost less money in Q2 2017 than in Q2 2016 (when it lost $21.2 million). So that's a plus.
The fact that Cubic was able to decrease its overall operating loss owes largely to this narrowed loss in defense systems.
Honey, we shrunk the cash
Cash production was another weak point for Cubic in Q2. Operating cash flow fell by roughly two-thirds to just $3.9 million during the quarter, bringing operating cash flow for the first half to $11 million. Capital investments also declined, but even so, free cash flow for the second quarter ran negative to the tune of $12.4 million.
This poor performance essentially negated all of Q1's positive cash production, and pushed Cubic's free cash flow for the first half into the red -- negative $4.2 million.
The future's uncertain
Of course, the really big news at Cubic this week was what management had to say about guidance -- or rather, what it couldn't say. Cubic warned that it can no longer give investors accurate guidance on earnings because there is a "potential for income tax expense volatility" this year. While the company is pretty sure it will be able to book between $1.5 billion and $1.54 billion in sales this year, it's less certain about what that will work out to on the bottom line.
Thus, Cubic's uncertainty about how Uncle Sam will treat the company, tax-wise, forced management to withdraw its EPS guidance for the year.
The upshot for investors
So how should an investor be thinking about Cubic in the absence of GAAP earnings guidance to rely on? I'd suggest you look at it like this. In last year's second half, Cubic Corporation generated positive free cash flow of about $71 million. But in this year's first half, that all went away, and the company is running a $4 million free cash flow cash deficit. This leaves Cubic with roughly $67 million in real cash profits generated over the past 12 months.
That's actually not half bad, though, for a company valued at $1.26 billion in market capitalization. It works out to a price-to-free-cash-flow ratio of 19. And with analysts who follow the company predicting Cubic will rebound to produce 28% annualized profits growth over the next five years, this week's weakness in Cubic's stock price just might provide investors a chance to buy it on the cheap.
That is, if they're brave enough to rush in where angels fear to trade.
