GEO - Government Contracts Trading Strategy

Summary

• As discussions about the trillion-dollar debt ceiling question intensify on Capitol Hill, we bring you one of our budget-spending-oriented trading strategies.
• While the largest and most unique government contracts catch media outlets' attention, most contracts end up being out of the news spotlight due to the sheer magnitude of government spending.
• The government contracts strategy aims to identify those blue-chip stocks and lesser-known companies that have been receiving a large number of awards from the government under the radar.
• This rules-based strategy holds a portfolio of the top 20 recipients of government contracts, weighted by the values of the announced contracts and rebalanced on a monthly basis.
• Current top holdings of the government contracts portfolio include companies such as Northrop Grumman, KBR, L3Harris Technologies, Regeneron, and GEO Group, among others.

As the debt ceiling battle escalates on Capitol Hill, discussions about the one trillion dollar question make us think it would be a great idea to look back upon one of our budget-based spending strategies. The Federal Government is recognized as the largest consumer in the United States, with its spending accounting for one-quarter of the GDP for the fiscal year 2022, or roughly $6.27 trillion, which pushes the budget way into deficit territory. To track which companies are benefiting the most from this spending, we have been scraping government spending data and publishing real-time insights on our web platform.

While the largest and most unique government contracts catch media outlets' attention, the majority of contracts are out of the spotlight due to the magnitude of government spending. The top recipients of government contracts oftentimes have numerous contracts that slip out of the public eye, due to many contracts being perceived as "business as usual" and therefore failing to attract headlines. We have scoured through exactly hundreds of those, looking to isolate which companies are the biggest recipients of such contracts that largely go under the radar.

However, even with transparency into who's receiving the money, it can still be difficult to make educated investing decisions with the vast amount of data that is collected. With this in mind, we've constructed a backtested trading strategy that tracks the performance of the largest publicly traded recipients of these government contracts. This strategy aims to identify a mix of blue-chip stocks and lesser-known companies that have been receiving a large number of awards from the government.

Analyzing Top Strategy Holdings

This rule-based strategy holds the top 20 government contract recipients, weighted by the announced contract values. Each company's government contracts are measured with an exponential moving average to favor more recent contracts while still considering older contracts. This portfolio is rebalanced at the start of every month, and the resulting balance of the two factors yields our current top 20 list. Without many surprises, the top recipients have often been largely a good mixture of well-known defense contractors and pharmaceutical companies such as Pfizer ( PFE ), Lockheed Martin ( LMT ), and Merck ( MRK ), but there are also some lesser-known, more on the sidelines type of players in the space.

There are twenty open positions in the government contracts strategy. The largest portfolio position at the moment is Northrop Grumman Corporation ( NOC ), which takes up 23.52% of the portfolio's NAV. It is closely followed by positions in KBR Inc. ( KBR ) and L3Harris Technologies ( LHX ), with them taking up 13.76% and 10.22% of the NAV, respectively. The fourth and fifth largest holdings being Pfizer and Regeneron Pharmaceuticals ( REGN ), which take up high single-digit percentages of the NAV, the portfolio is relatively top-heavy in terms of concentration.

Our Top Government Contracts Strategy managed to deliver a somewhat steady 20.00% CAGR over the course of the backtesting period dating back to March 1st, 2009. To place matters into context, this would mean that a $100 million investment at the start of the backtesting period in early 2009 would amount to a little more than $1.26 billion as of today. The portfolio hit its peak in December last year, reaching $1.36 billion at one point. The strategy started the year in single-digit losses but overall outperformed the S&P 500 ( SPY ) on a one-year basis by 16.26%.

Northrop Grumman Corp.

NOC is an American global aerospace and defense technology company. It represents our largest holding within the government contracts strategy and one of the most consistent contract receivers. Northrop received 3.70 million dollars from last month's contracts alone, most of it from the Department of Defense and NASA contracts. The firm is one of the world's largest defense contractors and a major producer of military and commercial aircraft, spacecraft, radar systems, and other defense and security systems. They are also involved in providing cyber security and information technology services, as well as logistics and technical support services. Some of its major divisions include Aerospace Systems, Mission Systems, and Technology Services. Northrop Grumman has operations in all 50 US states and in several other countries and is headquartered in Falls Church, Virginia. The company had a difficult start to the year, as it significantly underperformed the S&P 500 at the moment, but it also represents one of the companies that had a stellar 2022. For a company that is expected to grow its top line in the mid-single digit range over the next couple of years, Northrop is selling at a quite steep valuation. Given the current price, NOC is trading at an NTM EV/EBITDA of 15.84x, an NTM P/E of 20.09x, and an NTM P/FCF of 23.87x. For those willing to look past the premium valuation, the deal is sweetened by a 1.56% dividend yield. Both Seeking Alpha authors and Wall Street analysts consider NOC to be an attractive investment opportunity, rating the stock as a "buy" with an average rating of 3.66/5.00 and 3.85/5.00, respectively. Shares of Northrop Grumman are currently trading at $444.11.

KBR Inc.

KBR is a Texas-based engineering, procurement, and construction company, formerly known as Kellogg Brown & Root. The company specializes in a wide range of services, including engineering, construction, and operations and maintenance of government and infrastructure projects. KBR operates in three business segments: government services, technology and consulting, and energy solutions. The company's primary clients include government and private sector clients in the oil and gas, power, and chemical industries. KBR is headquartered in Houston and has operations in over 80 countries worldwide. The firm won $2.82 million of government contracts in December, the largest of which was a $1 million contract for Computer Facilities Management Services for the U.S. Geological Survey . KBR is another company that had a bumpy start to the year but still delivered an overall strong result with a 7.33% one-year return. As of late, Seeking Alpha authors have taken a liking to the stock, assigning it a "buy" rating with an average score of 3.50–5.00. Wall Street analysts on the other end have been much more bullish on KBR's prospects, assigning it a "strong buy" rating accompanied by a 4.72/5.00 score. KBR is another company that had a bumpy start to the year but still delivered an overall strong result with a 7.33% one-year return. This is yet another company priced at somewhat of a premium given that it currently sells for an NTM EV/EBITDA of 11.90x, an NTM P/E of 18.16x, and an NTM P/FCF of 18.24x. It is also accompanied by a token dividend of 0.98%. Shares of the company can currently be purchased for $51.22.

L3Harris Technologies, Inc.

LHX was formed a couple of years ago through a merger between L3 Technologies and Harris Corporation. It is a technology company in the business of providing a wide range of products and services for customers in the aerospace, defense, and security markets. The company operates in three main segments: communications, electronic systems, and space and airborne systems. It offers a wide range of products, including communications systems, electronic systems, and space and airborne systems for commercial and government customers. Some examples of its products include aircraft communication systems, navigation systems, surveillance and reconnaissance systems, and satellite systems. The last major contract was a later November $10,441,739 procurement deal coming out of the Department of Homeland Security. Over the last year, the LHX delivered a negative 14.23% return. This year isn't off to a much better start, having already dropped 6.13%. It is selling for an NTM EV/EBITDA of 12.37x, an NTM P/E of 15.64x, and an NTM P/FCF of 15.85x while offering an interesting dividend yield of 2.31%. Wall Street analysts rate the stock as a buy with an average rating of 3.85/5.00. Seeking Alpha Authors are also somewhat optimistic about LHX's prospects, giving it an average rating of 3.60/5.00. The company is currently selling its shares at $192.51 per share.

Pfizer

It is one of the largest and oldest multinational pharmaceutical corporations, dating all the way back to 1849.

The company develops and produces medicines and vaccines for a wide range of medical disciplines, including immunology, oncology, cardiology, and neurology.

Pfizer is one of the world's largest research-based pharmaceutical companies in terms of revenues, with annual sales close to $50 billion . The company has a strong portfolio of patented drugs, such as Lipitor (cholesterol), Viagra (erectile dysfunction), and Lyrica (neuropathic pain), and has collaborations and partnerships with many other companies in the pharmaceutical industry. Pfizer has generated a one-year negative return of 16.54%. It is selling for what seems to be a bargain price at an NTM EV/EBITDA of 7.13x, an NTM P/E of 10.44x, and an NTM P/FCF of 10.20x. Given the relatively attractive price, it is also the most attractive dividend offering on the list, with a 3.65% yield. The firm is consciously held in high regard by both Seeking Alpha authors and Wall Street analysts , who assign it a "buy" rating accompanied by 3.87/5.00 and 3.66/5.00 ratings, respectively. The company is currently trading at $43.41 per share.

Regeneron Pharmaceuticals

Is the second pharmaceutical company to find itself at the top of the government's contracts strategy portfolio, albeit much smaller than the previously mentioned Pfizer. We are discussing a Tarrytown-based biotechnology company that specializes in the discovery, development, and commercialization of medicines for serious medical conditions. Its primary focus is on developing treatments for diseases of the eye, cardiovascular disease, and cancer. REGN's most well-known product is Eylea, a treatment for age-related macular degeneration, which has become a significant source of revenue for the company. The company also has a pipeline of experimental drugs in various stages of development and clinical trials. Regeneron has significantly outperformed the market recently, generating a one-year return of 17.52% accompanied by a year-to-date performance of 1.32%. It is selling for an NTM EV/EBITDA of 10.64x, an NTM PE of 17.85x, and an NTM P/FCF of 17.22x. REGN, on the other end, does not offer a dividend yield to its investors. Despite this, Seeking Alpha Authors rated the company a "buy" with an average score of 3.50/5.00. Wall Street analysts rate the stock as a "buy" with an average rating of 3.76/5.00. REGN is currently selling at $767.10 per share.

Other holdings of the government contracts strategy include Maximus Inc. ( MMS ), General Dynamics ( GD ), Merck & Co., The GEO Group ( GEO ), Lockheed Martin Corp, Parsons Corporation ( PSN ), Raytheon Technologies ( RTX ), Viasat Inc. ( VSAT ), FedEx Corporation ( FDX ), Tutor Perini Corporation (TPC), Kelly Services Inc. ( KELYB ), QuidelOrtho Corporation ( QDEL ), Tetra Tech Inc. ( TTEK ), Motorola Solutions ( MSI ), and Aecom ( ACM ).

Closing thoughts

With this strategy, we have identified a series of potentially well-placed companies that have a long history of being tapped directly into the US government's budget. By scouring through thousands of filings, we have identified a mix of well-known blue-chip stocks, as well as some lesser-known companies that by themselves might be interesting for further research. However, by pulling them together, our strategy works by weighing the values of their received contracts over long periods of time, allowing for what we perceive as consistent outperformance.

For further details see: