Kratos has been on fire lately. In the past six months alone, the company’s stock price has rocketed 86.3%, reaching $108.08 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? Get the full breakdown from our expert analysts, it’s free.
Why Is Kratos Not Exciting?
We’re glad investors have benefited from the price increase, but we don't have much confidence in Kratos. Here are three reasons you should be careful with KTOS and a stock we'd rather own.
1. Free Cash Flow Margin Dropping
If you’ve followed StockStory for a while, you know we emphasize free cash flow. Why, you ask? We believe that in the end, cash is king, and you can’t use accounting profits to pay the bills.
As you can see below, Kratos’s margin dropped by 9 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 7.3%.
2. Previous Growth Initiatives Haven’t Impressed
Growth gives us insight into a company’s long-term potential, but how capital-efficient was that growth? A company’s ROIC explains this by showing how much operating profit it makes compared to the money it has raised (debt and equity).
Kratos historically did a mediocre job investing in profitable growth initiatives. Its five-year average ROIC was 3.2%, lower than the typical cost of capital (how much it costs to raise money) for industrials companies.
3. New Investments Fail to Bear Fruit as ROIC Declines
ROIC, or return on invested capital, is a metric showing how much operating profit a company generates relative 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. Over the last few years, Kratos’s ROIC averaged 4.4 percentage point decreases each year. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.
Final Judgment
Kratos isn’t a terrible business, but it doesn’t pass our quality test. After the recent rally, the stock trades at 159.7× forward P/E (or $108.08 per share). This valuation tells us a lot of optimism is priced in - we think there are better opportunities elsewhere. Let us point you toward a fast-growing restaurant franchise with an A+ ranch dressing sauce.
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