BAH - Booz Allen Hamilton: A Federal Contractor With High Valuation Worth Holding

2023-08-09 01:08:54 ET

Summary

• Booz Allen Hamilton Holding earns a hold rating, in line with the Seeking Alpha quant system.
• Positives: net income YoY growth, capital & liquidity strength, dividend yield above sector average. Top 3 federal government IT contractor.
• Headwinds: P/E and P/B valuation much higher than sector average, share price over 20% above 200-day SMA.

Research Brief

Behind the scenes of many roles & projects in the US federal government, particularly in the defense & intelligence sectors, is a company from McLean Virginia called Booz Allen Hamilton Holding ( BAH ).

While attending various business & innovation events in recent years in Austin, Texas, which is incidentally also the home of the US Army Futures Command, I got to know Booz Allen better through their presentations and info booth, but also from personal research that revealed how federal contracting is a multi-billion dollar a year industry with several major players.

Today I will rate this company whether it is a buy potential for investors, for those wanting to add or increase portfolio exposure to the "innovation" sector.

Some notable points about this firm, from its company website : multiple business segments including consulting, analytics, digital solutions, engineering, & cyber. Roots trace back to 1914. Around 32K employees. FY23 revenue of $9.3B. Trades on the NYSE.

Rating Method

I look for dividend opportunities & value plays among tech, financials, & innovation stocks. My rating analysis is broken down into rating 5 categories:

Valuation, Dividend Yield, Net Income Growth, Capital & Liquidity, Share Price.

To earn a "hold" rating the stock has to win on 3 of the 5 categories, and 4 out of 5 to earn a "buy" rating.

Valuation: Not Recommend

The first few metrics to talk about will be valuation metrics, specifically the forward P/E ratio and the trailing P/B ratio, taken from Seeking Alpha data .

As of August 8th, the P/E of 26.84 earned a pretty low grade and is almost 29% above the sector average. With a sector median around 21x earnings, I would be looking for this stock to be somewhere in line with or well below that, so in the range of 18x - 21x earnings. I consider this stock overvalued on this metric.

When it comes to P/B ratio, looking at the trailing twelve month ratio of 15.82 it scored an "F" from Seeking Alpha and is almost 500% above the sector average. Again, I am not privy to what all is included in the sector average, however based on this data the sector is around 2.6x book value yet this stock is almost 16x book value. I would consider this extremely overvalued on this metric.

From the evidence, I would not recommend this stock at this time based on its valuation, as it is far overvalued vs its sector.

Dividend Yield: Recommend

Although the dividend yield is not anywhere near some of the bank & insurance stocks I have been covering lately which hover between 5 - 8% yield in some cases, Booz Allen's dividend yield is a modest 1.53% as of August 7th, however it is paying quarterly and has steadily grown, currently at $0.47 per share.

If you look at the 5 year dividend growth, it is on a positive trend, having gone from an annual dividend of $0.76 in 2018 to $1.72 in 2022, a 126% increase in 5 years. If this trajectory continues, I expect it to hit an annual dividend of $2 within the next 5 years. That is a good sign for dividend-income investors looking to hold longer and grow the quarterly income.

In fact, if you look at the quarterly payouts, they have been steady and unbroken, and have grown steadily since 2020:

Important to this rating is how this stock's yield compares to the overall sector. If you look below, you can see that it is almost 1% above the sector average, so the two are pretty close.

Considering all the metrics above, I would recommend this stock on dividend yield.

Net Income Growth: Recommend

When looking at this firm's income statement , the company in the most recent quarterly result achieved a positive YoY increase in both net income and earnings per share, which in my opinion is a positive:

Now, let's take a closer look at this company's income streams, based on their 2024Q1 earnings release from July 28th. (note: this firm does not use a standard fiscal year).

In comparing figures in 2024Q1 with the prior fiscal year period, as shown above, this firm crushed it on all the key metrics including revenue, net income, earnings per share, and EBITDA.

It is a positive sign that this firm is winning both on the top line and bottom line, so I would gladly recommend it on the basis of net income YoY growth, an important category I look at to see that firm is managing both revenue and expenses effectively over a longer period such as 1 year.

Capital & Liquidity: Recommend

Let's take a look at the capital deployment of this company in the last several quarters, which shows a capital-rich firm that is spreading its cash around:

In the most recent quarter reported, $63MM went to dividend payouts, while $112.4MM went to share repurchases. In fact, you can see a steady uptick in the capital deployed to dividends each quarter.

The company also mentioned deploying $4MM through strategic investments & acquisitions. According to their quarterly presentation , "our capital allocation priorities remain: operating needs, quarterly dividend, strategic M&A, share repurchases, and debt repayment."

In looking at the meat & potatoes of a business, I care about this firm's balance sheet , which is a very large one. Its most recent quarter saw an increase in total assets to $6.7B:

Its liability side also increased:

The company has consistently had positive equity, however:

The company also has about $210MM in cash & equivalents, however it saw a decrease YoY.

According to the company's quarterly commentary :

Operating cash was seasonally light light due to timing of bonus payouts and continued spending on growth-oriented investments and working capital needs, but was aided by strong collection performance and overall revenue growth.

I see good reason to recommend this stock on the basis of capital & liquidity, as it continues to show strength in financial fundamentals.

Share Price: Not Recommend

As of the article writing, shares were trading around $123.75. In tracking the share price vs the 200-day SMA, it is 22% above this moving average right now.

My investing idea calls for tracking the 200-day SMA over a period of 1 year, and trading within a range of 5% of that moving average. In this case, with a 200-day SMA of $101.43, my trading range would be $96.35 - $106.50.

Though this seems like a simplistic method of trading, it can also pose the risk of short-term unrealized losses if the moving average does not go in our favor. That is why it should be looked at as a long-term approach.

The current share price, however, is outside of this trading range and so I would not consider it a good buy opportunity right now.

Here is an example trade simulation I created where I buy shares at the lower limit of my range, $96.35, hold for 1 year to earn the full year dividend income, then sell at my upper limit of $106.50, taking a capital gain:

In the above simulation, a total return on capital invested of 12.49% is achieved.

Ratings Score: Hold / Neutral

Today this stock won 3 of my 5 rating categories and is getting a "hold" rating. This is in line with the consensus from the Seeking Alpha quant system which also rated it a hold, however it is less bullish than the consensus from analysts and Wall Street, as seen below.

A hold rating is not a negative rating necessarily, as those investors who have been holding shares from a much earlier price such as when it was trading in the $90 range this spring, may be seeing upwards of 35% unrealized gains by now. The question is whether they decide to sell at this point and take the capital gain or continue to hold.

Risks to my Outlook: Federal Budgets

A risk to my neutral / hold outlook, considering that this firm is so dependent on federal contracts, is that there are cuts in federal agency budgets and therefore future contracts & revenue for this firm, making my outlook too positive. This also can be impacted by political sentiment depending on who has a majority in Congress and the White House.

Lately, the financial media has been abuzz with the Fitch downgrade of the US government's credit rating , which also shed light on a larger issue and another potential funding shutdown around the corner. According to a BBC article:

In June the government succeeded in lifting the debt ceiling to $31.4 trillion (£24.6 trillion) but only after a drawn-out political battle, which threatened to push the country into defaulting on its debts.

When Congress returns from its summer recess, lawmakers will have to work to reach an agreement on next year's budget before the end of September to prevent a government shutdown.

However, I would argue that Booz Allen can depend on its existing pipeline of government work and long-term contracts.

It also has a well-established position in the subsegment of federal contracting, IT solutions. As per the table below from Bloomberg , it is ranked 3 in this category, with $2.65B in contract obligations:

In addition, the company announced in June that they were awarded part of an US Internal Revenue Service contract with a ceiling value of $2.6B, that involves modernizing mission-critical applications efficiently and cost-effectively.

So, I think the immediate risk of federal budget cuts or funding shutdowns is not going to be a major risk to this firm. However, we should keep an eye on what happens with not only the next round of federal budget talks in Congress but also what federal departments end up decreasing or increasing certain programs that could impact contractors like this going forward.

Analysis Wrap Up

Here are the key points discussed today about this stock.

This stock got a hold/neutral rating today, in line with the consensus from the Seeking Alpha quant system.

Positives include: dividend yield vs sector average, net income YoY growth, capital /liquidity.

Headwinds include: valuation vs sector average, share price vs 200 day SMA.

The risk of federal budget cuts impacting this firm's business has been addressed and determined to be low risk at this time.

In looking forward, I think this stock has a good likelihood of continuing to beat earnings estimates, as it has in the last 4 quarterly results. I expect earnings beat around $0.13, which is the average of the last four beats.

However, while another earnings beat may give the stock some more bullish momentum around that time, I still think many investors will realize it is overvalued and either sell to take a gain or avoid.

Nevertheless, as a company it is certainly valuable to the function of many components of the federal government especially the national security sector, and its well-established foothold in this space will continue to give it tailwind as that sector attempts to adapt to the latest innovation & technology.

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