Leidos' (LDOS 0.37%) business is booming -- and it's about to boom even bigger.
Since its absorption of Lockheed Martin's IT division in 2016, revenue at the publicly traded IT powerhouse has more than doubled, from $5.1 billion in the year of the merger to $10.8 billion recorded over the last 12 months. Most of this growth, however, has not been in the business of defense contracting (Leidos' historical forte), where revenues are up 58% over the last four years. Rather, it's been in what were historically the company's smaller businesses of civil IT contracting (up 189% from 2016) and health IT (up 225%, all according to data from S&P Global Market Intelligence).
That's about to change, and in a big way.
Image source: Getty Images.
Leidos bags some billions
We know this because, in a posting on its daily digest of defense contracts Tuesday, the U.S. Department of Defense announced that the Defense Information Systems Agency has just awarded Leidos a competitive single-award, indefinite-delivery/indefinite-quantity contract worth...$6.52 billion.
Dubbed the Global Solutions Management -- Operations (GSM-O) II contract, this award hires Leidos to "support services for the operation, defense, and sustainment of the Department of Defense Information Network/Defense Information System Network" both within and without the continental United States.
Now, Leidos won't get all this money up front. The contract's stated period is five years initially, followed by two potential "option" awards to extend the contract for two years each, and a final one-year option period -- bringing the total duration of the contract to a decade.
What it means for Leidos investors
There are at least two ways to read all those numbers; while the Defense Department is almost incredibly transparent in publishing its contracts for everyone to see, it's not always entirely unambiguous in the language it uses. Viewed most optimistically, DoD is saying that Leidos will be paid $6.52 billion over five years ($1.3 billion per year) -- and might get even more money if the contract is extended to 7, 9, or even 10 years.
But let's take the more conservative view. Let's assume what DoD really means here is that Leidos has a contract for 5 years, and that contract might be extended as far out as 10 years -- in which case, the per-year value of Leidos' $6.52 billion contract works out to "only" $652 million.
That's still pretty good news for Leidos.
$6.52 billion from this single contract is significantly more money than Leidos booked in revenue at its defense solutions business last year ($5 billion). In the upcoming year, it's probably going to add about 12.5% to the growth rate at Leidos' defense business -- on top of whatever other revenue growth Leidos is able to achieve there.
$652 million grows Leidos' $10.2 billion in total annual sales by 6% -- all because of this one contract. It all but guarantees the increases in Leidos' sales that analysts are predicting over the next two years, outrunning the $618 million in sales growth being predicted for 2020 and the $470 million in sales growth predicted for 2021.
Really, about the only downside to this news is that because Leidos' 7% operating profit margin in its defense business is the weakest of the company's three divisions, a bigger defense segment probably means that Leidos' overall profit margin is going to take a dip in future years. But even so -- 7% of $6.52 billion means that Leidos investors can anticipate their company earning $457 million more profit over the next decade than it would have earned had Leidos not landed the GSM-O II contract.
So like I said: pretty good news.
But how good news is this for Leidos stock?
That call is a bit tougher. Still, with the stock now trading for about 15.3 times trailing free cash flow, with sales growing 9.5% before GSM-O II and perhaps as much as 15.5% after it, even a small decline in overall profit margin on that revenue has me thinking that this contract is big enough to move the needle and turn Leidos stock into a buy.
