Should Investors Nab Argon ST?

Warfare has come a long way from bashing the other guy over the head with a club or a big rock. You don't have to be an avid watcher of Mail Call to realize that advanced electronics and surveillance have become major parts of our modern military and constitute a substantial advantage for our forces.

That's good news for Argon ST (NASDAQ:STST), a small military contractor that specializes in the so-called C4ISR market (that's command, control, communications, computers, intelligence, surveillance, and reconnaissance). So long as the military has the will and the funding to develop ever-more-complex systems, Argon ST has a market opportunity.

Results for the company's fourth quarter were solid. Reported revenue rose more than 100% in the quarter, and pro forma revenue (that is, assuming that the merger between Argon and Sensytech had been in effect last year) climbed about 47%. Margins weren't quite so hot, though, as pro forma operating income rose about 17%. Nevertheless, the company met the mean analyst estimate.

Although advanced electronics are in demand, Argon ST is in a tricky spot. Nearly 90% of the fiscal year's sales came from the U.S. government, with about 69% of that coming from the Navy. That sort of dependence could be dangerous if or when Congress becomes less interested in spending money on new defense projects and/or the military prioritizes its budget away from signals intelligence and electronic warfare -- unlikely as that might seem today.

Part of this risk is highlighted by recent concerns about a stop-work order on the Aerial Common Sensor (ACS) program. Argon ST is working with Lockheed Martin (NYSE:LMT) on this project, and it's unclear whether the program will be canceled or significantly recrafted. While the company's guidance for next year looks OK either way, the ACS program could be worth hundreds of millions of dollars in eventual revenue. Even though the company has appealing possibilities for new awards and growth (like a new recent agreement with the Army relating to explosive device systems), cancellations and modifications are a real risk.

Companies like Applied Signal (NASDAQ:APSG) and Engineered Support Systems (NASDAQ:EASI) have shown that small defense names can be risky. Of course, as we saw today in the deal between General Dynamics (NYSE:GD) and Anteon (NYSE:ANT), larger players are willing to step in if valuations on appealing companies get too low. Argon ST could offer a rocky ride from time to time, but so long as better intelligence and electronics are a driving priority in the military, Argon ST could be worth keeping on the radar.

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Fool contributor Stephen Simpson has no financial interest in any stocks mentioned (that means he's neither long nor short the shares).