I love companies that pay big dividends -- except when I don't.
Don't get me wrong. It's great when a company earns profits and can use those profits to pay dividends. But when a company is not earning a profit, paying out what little cash it does have in the form of a dividend is crazy. No matter how much I might want to cash a check, if the company needs to employ its cash for another purpose, I'd really rather that they do that.
What better uses might a company find for its cash if not pay dividends? Well, it might use cash to buy back shares when they are undervalued, concentrating future profits among fewer shares outstanding and thus growing profit per share faster than it might otherwise grow. Or the company could use cash to pay down debt, lowering its interest costs -- and thus again helping profits per share grow. Or the company might use cash to reinvest in its own business, taking advantage of new opportunities and -- you guessed it -- growing profits.
Cash for a rainy day
Take Kratos Defense & Security Solutions (NASDAQ:KTOS) for example. One of the smaller publicly traded defense contractors an investor can buy, Kratos doesn't pay any dividend at all. That's OK with me because right now Kratos is not profitable. And even in years when Kratos has earned profits, the company has generally eschewed dividends.
Why is that? In part, I suspect, it's because Kratos didn't want to commit itself to a regular dividend that it would not be able to afford to pay in "down" years. Kratos' periods of profitability have been fleeting, with profitable years quickly followed by unprofitable years. More importantly, Kratos doesn't pay a dividend because, as a growth stock, Kratos needs every dollar it can lay hold of to grow its business and expand into new fields.
Cash for growth
For example, Kratos has for years been a major supplier of unmanned aerial vehicles (UAVs or drones) that the military uses for target practice. This is still a big part of Kratos's business today -- in fact, the company just landed a big contract to supply subsonic aerial targets (SSATs) to the U.S. Navy.
But Kratos is also capitalizing on its UAV experience to develop a new type of drone -- jet-powered and weaponizable, but unmanned and capable of supplementing manned fighter aircraft in combat operations.
Kratos has multiple contracts in the works to build multiple types of combat drones for the military, contracts that could be worth billions of dollars in new revenues for the company once the contracts are finalized and the Pentagon begins buying Kratos's drones in real volume. Relative to the $76 million in revenue that Kratos's drones division booked last year, mostly for the sale of target drones, this is an opportunity that's literal orders of magnitude bigger than what Kratos makes today. Indeed, if the combat drone business proves out, Kratos' drones division could one day dwarf the company's "government solutions" electronics, satellites, and training division -- currently Kratos's flagship division at $466 million in annual revenue.
If and when Kratos succeeds in developing this new class of drones and getting them adopted by the military, the company should have more than enough cash flowing in to fund a respectable dividend yield. Until that happens, dividend-seeking investors will have to wait -- and they should be glad to do so.