Booz Allen Hamilton (NYSE:BAH) just wrapped up a strong quarter and voiced optimism in its outlook for its new fiscal year. That's great news for Booz Allen shareholders, but the factors driving the company are also reasons for investors to take a long look at the entire government IT sector.
Booz Allen reported fiscal fourth-quarter earnings per share of $0.52, $0.06 ahead of estimates, on revenue of $1.64 billion. Shares of the company jumped 8% in the two days following the release, perhaps because of management's confidence that its fiscal 2019 will produce 6% to 8% revenue growth at an EBITDA margin of about 9%.
"We feel really good about where we are in this year, we feel good about the market, the strength of the market, it's frankly for my money one of the best markets we've seen at least in the last five years," CEO Horacio Rozanski told investors during its quarterly conference call on May 29.
The spigot (finally) opens
During the latter half of the Obama administration, a time of frequent budget battles with a Republican-led Congress following the imposition of sequestration and spending caps in 2011, government IT projects largely were put on hold in favor of weapons procurement. Those caps were lifted in the two-year budget deal reached earlier this year, and the long list of IT projects put on hold is finally being addressed.
That's good news for the entire government IT sector, Booz Allen included.
"With greater budget certainty, our clients are more inclined to undertake the visionary work associated with upgrading and modernizing their own capabilities," Rozanski said. "With government funding now beginning to flow, we are seeing lots of opportunity across our contract and client base from defense to intelligence, to civil agencies."
Adjusted EBITDA margin for fiscal 2018 came in at 9.5%, in part due to lower-than-anticipated billable expenses in the fourth quarter, but if those levels of contract profitability can hold, the company's 9% projection for fiscal 2019 might prove conservative should higher contract volumes help spread operating expenses over a broader base. Booz Allen also benefited from a small but growing commercial and international business, up 30% for the year and generally more profitable than its government work.
Even after the post-earnings jump, there is a near-term catalyst that could send share even higher. The company hosts its investor day on June 6. Based on the optimism on the call, it seems likely Booz Allen will provide multiyear projections for revenue and earnings growth.
No need for mergers and acquisitions
Scale matters in the government IT business, as larger companies are better able to manage the increasingly large and complex systems customers demand, and a broader cost basis helps in putting together low-cost, competitive bids. In recent years, a wave of mergers and acquisitions has left a clear top two in the market. Industry leader Leidos Holdings (NYSE:LDOS) in 2016 bought the IT business of Lockheed Martin, while General Dynamics (NYSE:GD) vaulted to No. 2 earlier this year via its acquisition of CSRA.
But Booz Allen, just 60% the size of Leidos in terms of annual revenue, says it is not focused on transformational mergers and acquisitions. The company in recent years has tried to differentiate itself as a hybrid consulting/IT firm, and said it is more focused on attracting and retaining new employees than it is doing a big acquisition.
The company added 1,300 new employees in fiscal 2018, its largest head count growth in seven years. Rozanski said the bulk of that growth is for work "that's more technical in nature," including employees that either have or will qualify for clearance to work on a range of government projects. Deals, if they happen, are more likely to be focused acquisitions that add some specific capacity that Booz Allen believes can help it fuel organic growth in different parts of the enterprise.
"We're focused on winning work that is not only high priority for our clients but also mission essential and therefore less sensitive to budget shifts," Rozanski said. "Our firm has the right culture, planned relationships, contract base, scale and agility to continue growing and evolving our market position."
Issues from Booz Allen's recent past still hang over the company, including it being the employer of NSA leaker Edward Snowden and Harold Thomas Martin III, who was accused in 2016 of theft of government property and the removal of classified documents. More recently, the company's shares dropped nearly 20% last summer after the Department of Justice launched a probe into its accounting.
Rozanski told analysts the DOJ investigation is ongoing, and Booz Allen continues to cooperate, but offered no guidance on when it might be resolved or what the financial impact might be beyond the $8 million in legal costs the company has already incurred. The market has seemingly moved on, however. Shares of Booz Allen are up 17.75% year to date, and in early April climbed above their trading range when the probe was first announced.
Why government IT's a buy
The DOJ probe is a legitimate reason for hesitation, and in my mind the only thing stopping Booz Allen from being a definite buy. I expect it to be resolved without a material impact, but I prefer to avoid companies with open government investigations, especially in a sector where there are so many other good companies to consider.
The real takeaway from the Booz Allen call is the optimism that, after so many years on the back burner, government IT procurement really is back as a priority and new opportunities are on the horizon. That makes Leidos and smaller players like ManTech International (NASDAQ:MANT) attractive, as well as General Dynamics, even if Booz Allen is of no interest while the investigation continues.
The defense primes and equipment makers enjoyed most of the gains in 2017, but 2018 is shaping up to be a strong year for the tech side of the defense business. It's not too late to buy into this sector.