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Why Shares of Kratos Defense Are Diving Today

By Lou Whiteman – Sep 23, 2019 at 1:00PM

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After a strong surge higher, this defense stock has hit some turbulence.

What happened

Shares of Kratos Defense and Security Solutions (KTOS 3.30%) fell more than 10% on Monday after the company lost out to Northrop Grumman for a hypersonic test drone contract award. The bull case for this company remains intact, but the company faces a slower climb ahead.

So what

Kratos' shares have gained 172% over the past three years, even accounting for Monday's decline, on growing investor excitement about its drone portfolio. The company's Valkyrie "loyal wingman" drone, designed to fly into combat alongside crewed fighters and provide extra firepower or act as a decoy, is currently being tested by the Air Force.

Kratos' Valkyrie drone in flight.

Kratos' XQ-58A Valkyrie drone during a test flight. Image source: Air Force photo by 2nd Lt. Randolph Abaya, 586 Flight Test Squadron.

If all goes well, the Pentagon could end up ordering hundreds of drones at a price of $2 million to $3 million apiece in the years to come, a potential needle mover for a company that currently does less than $200 million in quarterly revenue.

But the share price momentum has stalled in recent months, and the stock is down nearly 25% since the company's late-July earnings release, in which it delivered guidance that was more conservative than many had expected. The caution was likely prudent -- Pentagon awards take considerable time to play out -- but the guidance, like this latest award to Northrop, is taking some of the wind out of the sails of what has been a strong momentum stock.

Now what

Kratos is considerably more volatile than most defense stocks, but the company still has significant potential, even after a turbulent few months. The Valkyrie is performing well in tests and fulfills a Pentagon need, and Kratos has nearly a dozen other advanced drone platforms in the works to address various uses and missions, some classified.

The volatility is likely to continue, and Kratos as it matures might find it hard to replicate the substantial gains of the previous few years in the next three. But for those with a stomach to ride through the bumps, this still looks like a long-term winner.

Lou Whiteman has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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