What a time it’s been for Kratos. In the past six months alone, the company’s stock price has increased by a massive 52.4%, reaching $40.77 per share. This was partly due to its solid quarterly results, and the run-up might have investors contemplating their next move.
Is there a buying opportunity in Kratos, or does it present a risk to your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.
Why Is Kratos Not Exciting?
Despite the momentum, we're swiping left on Kratos for now. Here are three reasons why KTOS doesn't excite us and a stock we'd rather own.
1. Free Cash Flow Margin Dropping
Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
As you can see below, Kratos’s margin dropped by 7 percentage points over the last five years. Almost any movement in the wrong direction is undesirable because it is already burning cash. If the trend continues, it could signal it’s becoming a more capital-intensive business. Kratos’s free cash flow margin for the trailing 12 months was negative 3.8%.
2. New Investments Fail to Bear Fruit as ROIC Declines
A company’s ROIC, or return on invested capital, shows how much operating profit it makes compared to the money it has raised (debt and equity).
We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Unfortunately, Kratos’s ROIC has decreased over the last few years. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.
3. Short Cash Runway Exposes Shareholders to Potential Dilution
As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.
Kratos burned through $44.4 million of cash over the last year. With $263.7 million of cash on its balance sheet, the company has around 71 months of runway left (assuming its $184.2 million of debt isn’t due right away).
Unless the Kratos’s fundamentals change quickly, it might find itself in a position where it must raise capital from investors to continue operating. Whether that would be favorable is unclear because dilution is a headwind for shareholder returns.
We remain cautious of Kratos until it generates consistent free cash flow or any of its announced financing plans materialize on its balance sheet.
Final Judgment
Kratos isn’t a terrible business, but it isn’t one of our picks. After the recent surge, the stock trades at 75.1× forward P/E (or $40.77 per share). This multiple tells us a lot of good news is priced in - we think there are better stocks to buy right now. We’d recommend looking at a fast-growing restaurant franchise with an A+ ranch dressing sauce.
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