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Why Shares of Kratos Defense Are Higher Today

By Lou Whiteman – May 8, 2020 at 12:23PM

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One of the defense sector's most divisive stocks continues to show signs of maturing into a more reliable contractor.

What happened

Shares of Kratos Defense & Security Solutions (KTOS -2.22%) climbed 15% at the open Friday after the company posted first-quarter numbers that came in ahead of expectations. The shares gave back some of the gains as the morning went on, but the bulls are definitely in control in Friday trading of one of the most volatile stocks in the defense sector. As of 12:15 p.m. EDT, shares were up nearly 13%.

So what

After markets closed Thursday, Kratos reported first-quarter earnings of $0.09 per share on revenue of $168.9 million, topping expectations for $0.07 per share in earnings on $164 million in sales. Revenue was up 5.3% year over year, but adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA), at $16.3 million, was down 6.9% from the first quarter of 2019 due to increased research and development efforts.

The Valkyrie soars over a desert sky.

The Valkyrie in flight. Image source: Air Force photo by 2nd Lt. Randolph Abaya, 586 Flight Test Squadron.

The company is taking a conservative view of the quarters to come, largely because it expects the COVID-19 pandemic to impact suppliers and customers. Kratos also had an option on an international training contract go unrenewed. The company expects second-quarter revenue to land between $160 million and $170 million, short of the consensus $188 million estimate, and full-year 2020 revenue of $720 million to $760 million, down from previous guidance for $740 million to $780 million in sales.

Kratos is the maker of a range of drone and defense electronics products, but investors are most excited right now about the company's Valkyrie "loyal wingman" drone concept. The Valkyrie is a complex, high-powered aircraft designed to fly alongside crewed fighters to provide extra firepower and act as a decoy.

The Valkyrie has done well in Air Force testing, and investors hope that 2020 will be the year that Kratos gets an initial government production contract. Kratos' 2020 guidance excludes any Valkyrie or other drone production contracts, but its 2020 capital expenditure forecast does include funds to produce 12 Valkyrie drones prior to the receipt of a customer award.

That means the company is taking on risk now in hopes of getting a contract later. It's unclear whether issues including the pandemic forcing Pentagon employees to work from home will delay contract awards.

Now what

Kratos is the rare high-risk, high-potential-reward stock in the mostly staid world of defense investing. The company has a bit of a checkered past and in 2018 was the target of a short-seller. It also has operational risk committing its own capital to build 12 Valkyrie drones prior to winning a Pentagon deal, especially since Boeing is developing a rival to the aircraft.

I'm still hopeful Kratos will get an initial Valkyrie contract this year, and overall I see this earnings report as fresh evidence the company continues to mature into a more reliable, predictable defense contractor. Investors seem heartened by the results even with the conservative guidance.

Lou Whiteman owns shares of Kratos Defense and Security Solutions. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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