BWXT - BWX Technologies: A Lot Of Potential But Rich Valuation

2023-10-24 03:46:03 ET

Summary

• BWX Technologies is a niche company that builds and sells nuclear components, technologies, and services to government and commercial customers.
• The company's government segment, which serves the US government and Navy, provides stable and predictable earnings due to long-term contracts and high barriers to entry.
• BWX Technologies also has a commercial segment that manufactures heavy nuclear components and has recently entered the medical industry, offering growth opportunities.
• While the company enjoys a near monopoly status in its business, its valuation is getting a bit too rich to offer a margin of safety.

BWX Technologies ( BWXT ) is a unique company in a niche position. It builds and sells nuclear components, nuclear technologies, and nuclear energy-related services to a number of large customers including the US government, the US Navy, the nuclear power industry, and medical industry. The majority of the company's business comes from government contracts especially related to the navy as many of its assets such as aircraft carriers are nuclear-powered.

Last year the company created two groups within itself to better address its customers. Now it consists of two major segments called Government and Commercial and each segment is responsible for serving its own type of customers.

The company has been around for a very long time and it has deeply established relationships with the US government going back to 1950s. Also due to the heavily specialized nature of its business and its specific types of patents, it enjoys a pretty large moat and virtually very little competition. Since the company's products and services are backed by many years' worth of costly advanced research and government regulatory standards defining these products are highly specific and can't be easily met by newcomers, the barrier of entry for other companies is very costly which makes the company's Government segment's earnings pretty stable and predictable for years to come.

The company works very closely with government agencies such as the Department of Energy as well as military branches such as the Navy to see where future needs are and allocates its research budget to those high-priority areas which ensures not only that it will continue to generate income from those customers but also that its relationships will get more entrenched over time and it will be able to achieve more favorable contracts.

The company's non-government segment (Commercial segment) has also been very busy with providing its customers with a large number of products including but not limited to nuclear steam generators, heat exchangers, pressure vessels, nuclear fuel, fuel handling systems, nuclear-grade materials, and related engineering services. The company's commercial segment has global customers and happens to be the only company in North America that manufactures heavy nuclear components, which gives it a moat. Recently the company also started working with the medical industry as its products and services can be used in diagnostic imaging technologies. This sub-segment will likely provide more growth opportunities for the company moving forward.

Roughly three-fourths of the company's revenues and income come from government contracts (76% to be specific) and the company's biggest customer is the US government. This comes with both advantages and risks. The biggest obvious risk is that if the company were to somehow lose its relationship with the US government it would take a pretty massive hit in a way the entire company's existence would be in jeopardy but it's highly unlikely for the reasons mentioned above. On the other hand, the company's business is non-cyclical so it's expected to perform well regardless of economic cycles. Since its contracts are multi-year long, the company's finances will be highly stable, predictable, and safe for the most part. This is also the only company within the US that has NRC Category 1 licenses which gives it a huge advantage.

Since its IPO, the company saw total returns of 517% which beat overall market returns of 401% during the same period. It will be interesting to see if this performance can be sustained in the future because the company's valuation reached rich levels in the last couple years as I will discuss below but its past performance has been impressive, to say the least.

The stock has a dividend yield of 1.2% which isn't much to boast about but it has an impressive dividend growth history. Since 2013, BWXT saw its dividends almost triple which makes this a good candidate for dividend growth investors. Moving forward, the company plans on spending 50% of its free cash flow on dividends and stock buybacks.

Having said that, it is possible that this company's stock performance probably went ahead of itself in recent years. In the last 5 years, the company's net income was flat and its EPS was only up 8% (mostly due to share buybacks) whereas its stock is up 114%. Investors have been increasingly bullish about this company in recent years but it will have to show some growth to justify its current valuation. Sure, having a lot of Federal contracts gives this company a level of predictability and stability but its overreliance on government contracts also limits its growth rate.

In recent quarters the company generally beat estimates and continued growing its revenues at a decent rate but this didn't necessarily translate into higher net income as the company's margins suffered somewhat due to higher costs. Some of the higher costs were due to the company's hiring of a large number of new employees, which contributed significantly to its operating costs. As a result of this, the company's income was down almost 10% year-over-year even with its revenues being up 11%. On the other hand, the company's cash flow generation has been improving as a result of better capital management and less capital spending.

The company will announce its results for the next quarter in early November. I expect the company to continue posting revenue growth close to 10% and improvements in its net income and cash flow as the company continues to tighten its cost structure. It is likely that the company will be able to pass some of its higher costs to customers by increasing its prices since a lot of its contracts have inflation adjustments built into them already. By the end of the year, the company should have little trouble meeting its year-end guidance which it originally provided in February but reiterated in May and August.

The company's valuation looks rich no matter which metric you look at. Its valuation looks rich on GAAP earnings as well as non-GAAP earnings. It looks rich on trailing earnings as well as forward earnings. Its PEG ratio of 3.72 tells us that investors are pricing in some future growth that might or might not come. The company will have to show some real growth to show that it deserves its current share price as it trades at a premium of at least 30%. Currently, the company's P/E ratio is 26 on a non-GAAP basis and 31 in GAAP basis, which compares to the sector median of 16 on a non-GAAP basis and 18 on a GAAP basis. The company's current valuation is also significantly higher than its 5-year average P/E, which ranges from 19 to 21 depending on whether you are looking at GAAP or non-GAAP earnings. The market probably justifies this P/E premium enjoyed by the company as its earnings seem to be more stable and predictable which is liked by the market but still, this much premium might not be justified and a pullback might be beneficial for new investors to obtain a better entry point.

The company currently appears to be at crossroads. On one side it's trying to cut its costs in order to improve margins and it has committed to cutting its capex by $200 million but on the other hand, it has a pretty large backlog and it needs to increase its production. It also needs to increase R&D spend in order to bring new products to the market.

In the next 20-30 years we are seeing a secular trend in increased usage of nuclear products in many different areas from military usage (not nuclear weapons but nuclear-powered submarines, aircraft carriers, and so on), to energy generation, from medical usage to other uses within the scientific community. There will be more need for many different product types that fall into nuclear theme and there are very few companies that offer highly specialized products and services in this particular field. If managed well and safety precautions are taken, nuclear power is one of the cleanest and most sustainable sources of energy and there will be more of it in the future despite some countries like Germany closing down their nuclear power plants due to environmental fears. Countries like China will keep increasing their nuclear power generation and there will be a need for lots of electric power in the future as electric vehicles take off. Also, as the usage of AI increases, there will be bigger power needs that only nuclear power can address because servers and data centers utilizing AI will be using massive amounts of data.

In the long run, demand for nuclear products will be robust but in the short term, the company's valuation appears to be a little ahead of itself, especially after rallying 40% year-over-year. I'd recommend buying this company after it experiences a meaningful pullback but current prices are probably too high to get in.

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