Company Overview: Science Applications International Corporation (NYSE: SAIC) is a technology integrator, which is engaged in offering high-end solutions in engineering, IT, and mission solutions throughout the defense, space, civilian, and intelligence markets. The company has a successful history of more than 50 years serving different government agencies, including the U.S. military; the U.S. Defense Logistics Agency; the U.S. Department of State; the National Aeronautics and Space Administration; and the U.S. Department of Homeland Security. The company serves its customers with more than 25,500 employees. 

SAIC Details 

Buyout Synergies and Contract Wins Are Key Positives: Science Applications International Corporation (NYSE: SAIC) is involved in offering information technology and professional services, mainly to the United States. FY20 has been an exciting year for SAIC with a rejuvenated strategy, and the continuous dedication to help its customers’ missions with new capabilities, solutions, and technologies. The addition of Engility and now Unisys Federal, positions the company to be the preferred technology partner for its customers powered by the best talent in the industry. 

In FY20, the company delivered robust profitability along with cash generation, which exceeded SAIC’s performance goals. In FY20, the company reported revenues of ~$6.38 billion, of which ~98% came in from the U.S. government. The company improved its adjusted EBITDA margins by 80 basis points and increased its year-over-year free cash flow to $437 million, up by $281 million. The company recorded $15.3 billion of total contract backlog during the period, which marked the highest record in the last six-year history of the company and demonstrates its strong footing for revenue growth. 

Despite the budget and aggressive rivalry pressures impacting the industry, the company is well-placed to safeguard and increase its existing customer base. The company’s robust scale, size and prime contractor leadership gives the company a competitive lead in the market, particularly on large contracts. In 2019, the company completed the acquisition of Engility Holdings, Inc. The buyout is expected to be a key driver in implementing its long-term strategy to be the premier technology integrator in the government services market and deliver sustained profitable growth. The acquisition also boosted the company’s margin profile and cash-flow generation capacity. In 2020, the company completed the acquisition of Unisys Federal which was in-line with the company’s long-term strategy.
 

Looking ahead, the company is set to gain from several government contracts, which lends stability to its business and manages variation in revenues. The company witnessed a CAGR of 10.3% and 18.3% in revenue and net income, respectively over the period of FY16-FY20. Dividends also increased from $1.21 per share in FY16 to $1.48 per share in FY20, instilling investors’ confidence. 

Past Performance (Source: Company Reports) 

It is worth noting that the company will benefit from the continued flow of high-value contracts. The company’s total contract backlog stood at $16.6 billion as of May 1, 2020. The company’s mission-critical work, long-term contracts, a flexible operating model, and cost structure, along with supportive government customers are expected to aid the company’s growth, going forward. SAIC’s results are likely to benefit from a robust product portfolio, which, in turn, will boost the top-line and support the growth. The company’s capability to maintain its existing contracts along with the newly awarded ones throughout the customer portfolio is expected to be a tailwind in the near-term. 

Sneak Peek at Q1FY21 Key Highlights: During the quarter, the company reported adjusted earnings of $1.38 per share, as compared to $1.36 per share reported in the year-ago period. SAIC reported revenues of $1,757 million, soaring 9% from the prior corresponding period, on the back of acquisition synergies of Unisys Federal. The company stated that its business remained strong amid the coronavirus-led crisis, which had a limited impact on its quarterly results.  During the quarter, the company reported net bookings of $1.6 billion, indicating a book-to-bill ratio of 0.9. During the quarter, the company reported non-GAAP operating income of $106 million, up 5% on pcp. Adjusted EBITDA for the quarter stood at $137 million, up from $135 million in the year-ago quarter. 

1QFY21 Key Highlights (Source: Company Reports) 

Balance Sheet & Cash Flow Highlights: The company exited the quarter with a cash balance of $276 million, with total debt (long plus short) amounting to $2,884 million. The company reported operating cash flow of $367 million, as compared to the year-ago figure of $178 million. The healthy expansion shows cash provided from operating activities of Unisys Federal and $200 million of sales of receivables under the Master Accounts Receivable Purchase Agreement (MARPA). In 1QFY21, the company reported a free cash flow of $158 million. In 1QFY21, the company also implemented $39 million of capital, which included $23 million in dividend payments and $16 million to mandatory debt repayment. 

Balance Sheet Highlight (Source: Company Reports) 

SAIC Rides on Contract Wins: Recently, SAIC won a $630 million contract from the U.S. Air Force for a term of 5 years to manage and update the critical hardware and software for its Technology Application Development and Sustainment (TADS) system. SAIC will assist the expansion of precision and correctness of weather reports. In another update, the company also won a five-year contract worth $2.9 billion to keep supporting the U.S. Army with its mission engineering capabilities. The company also obtained a $378 million, single-award, indefinite-delivery, indefinite-quantity (IDIQ) contract to distribute its enterprise IT services to the Federal Aviation Administration (FAA). At the beginning of June 2020, the company also received a single-award, cost-plus-fixed-fee, and firm-fixed-price contract worth $60 million to continue providing engineering support to the U.S. Navy. 

Recent Updates: 

1. On July 7, 2020, the company published its “Sustainability and Social Responsibility Report”, highlighting the key developments made by the company. Some of the highlights presented in the report are 36% reduction in greenhouse gas emissions in the past 4 years, robust corporate governance, acknowledgment as the leading public company in the Washington, DC area for female board members, as well as donating more than 2 million meals to Feeding America to fulfill the hunger needs in the U.S.

2. On June 18, 2020, the company announced that it has appointed Terry Biggio as its Senior Director of business development for the Federal Aviation Administration (FAA) and the Department of Transportation (DOT).
 

Top 10 Shareholders: The top 10 shareholders have been highlighted in the table, which together forms around 43.15% of the total shareholding. The Vanguard Group, Inc. and BlackRock Institutional Trust Company, N.A. holds the maximum interests in the company at 9.63% and 9.35%, respectively. 

Top 10 Shareholders (Source: Refinitiv, Thomson Reuters) 

Key Metrics: The Company reported May’ FY21 gross margin at 10.4%. ROE, in the same time span, stood at 2.6%, higher than the industry median of 2.4%. May’ FY21 debt to equity ratio stood at 2.07x. In 1QFY21, the company made a deliberate debt repayment of $125 million and is assertive on the de-leveraging plan as earlier conveyed.
 

Key Metrics (Source: Refinitiv, Thomson Reuters) 

Key Risks: The company generated more than 95% of its revenues from contracts with the U.S. government, in each of the last three fiscal years, which included contractors or subcontractors. The company also expects to gain significantly from work completed under U.S. government contracts. As the company heavily depends on U.S. government agencies as its primary customer, the loss of any of these agencies could unpleasantly impact future revenues and cash flows. Additionally, stiff competition from peers like General Dynamics, Northrop Grumman, Accenture, IBM, Unisys, and Agility Logistics, along with a leveraged balance sheet adds to the woes.

Future Expectations: In FY21, the company expects to remain resilient, and profitable by taking necessary steps to invest higher in key planned areas. Further, it also expects to leverage its new market access and capabilities from the buyout of Engility and Unisys Federal. For FY21, SAIC expects revenue to be in the ambit of $7.1 billion and $7.3 billion, which suggests 1% to 4% organic growth. The revenue outlook also reflects 10.5 months of business operation of the recently acquired Unisys Federal business and an unfavorable impact of $150 million from the coronavirus pandemic. Adjusted EPS for FY21 is likely to be between $5.80-$6.10, which comprises $25 million adverse impact from COVID-19 crisis. Free cash flow is likely to meet or surpass $500 million in FY21. 

Key Valuation Metrics (Source: Refinitiv, Thomson Reuters) 

Valuation Methodology 1: P/E Multiple Based Relative Valuation (Illustrative)

P/E Based Valuation (Source: Refinitiv, Thomson Reuters) 

Valuation Methodology 2: EV/EBITDA Multiple Based Relative Valuation (Illustrative)

EV/EBITDA Based Valuation (Source: Refinitiv, Thomson Reuters) 

Note: All forecasted figures and peers have been taken from Thomson Reuters, NTM-Next Twelve Months 

Stock Recommendation: The stock of SAIC closed at $73.11 with a market capitalization of ~$4.25 billion and current yield of 2.08%. The stock made a 52-week low and high of $45.45 and $96.8, respectively and is currently trading slightly above the average of its 52-week trading range. The stock corrected ~11.33% in the last three months. The company declared an interim dividend of 37 cents per share, which will be payable on July 31, 2020, with an ex-dividend date of 16 July 2020. In 1QFY21, the company recorded year-over-year growth in both revenues and earnings, owing to higher contract wins and acquisition synergies. Considering the above factors, we have valued the stock using two relative valuation methods, i.e., P/E multiple and EV/EBITDA multiple and arrived at a target price with an upside of lower double-digit (in % terms). For the purpose, we have taken peers like CACI International Inc (NYSE: CACI), General Dynamics Corp (NYSE: GD), Leidos Holdings Inc (NYSE: LDOS), to name few. Hence, we recommend a “Buy” rating on the stock at the closing price of $73.11, up 3.32% on 15 July 2020. 

SAIC Daily Technical Chart (Source: Refinitiv, Thomson Reuters)

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