2023-12-13 01:09:24 ET
Summary
- CACI International operates in a tight-margin business.
- The company has a decent amount of debt, but solvency ratios indicate that it is managing leverage properly and is not at risk of insolvency.
- CACI's profitability and margins have been consistent but not improving, making it less attractive for investment. The company's backlog, however, provides stability for future operations.
Investment Thesis
I wanted to look into CACI International´s ( CACI ) finances in a bit more detail to see how it has been operating in the recent past and if it showed any improvement. The company seems to operate in a tight margin business and unfortunately, the company´s growth in sales is accompanied by a larger growth in costs, which makes the company less efficient and squeezes margins further. With no clear trend in efficiency and profitability, I initiate my coverage of CACI with a hold rating, until I see solid margin improvement.
Briefly on the Company
CACI International is an IT solutions and services provider, that specializes in national security and helping government modernize their business processes with enterprise resource planning or ERP. The company offers a wide range of services including cybersecurity, command and control systems, space operations, business systems, and healthcare solutions.
The company helps governments and military to keep their information safe from hackers, building systems to control missions and keep their operations modernized and up to date.
Financials
As of Q1 ´24 , the company had around $125m in cash and equivalents against around $1.7B in long-term debt. That is quite a decent amount of debt, which may put off a couple of investors. Debt is not bad as long as it is managed properly. There are a few solvency ratios I like to look at to see if the company is using leverage smartly and not being overwhelmed to the point that the debt provides a huge risk in the long run. The CACI´s debt-assets ratio has been hovering around 0.30 over the last 5 years, which is a good number to be in. It means that the company has much more assets than debt, and the range between 0.3-0.6 is considered to be not too leveraged.
The debt-equity ratio has been in a good range of 0.50-0.70. Anything under 1.5 is considered good, so the company doesn't seem to be using too much debt for its operations. Lastly, I like to look at the company´s performance against what it owes in annual interest expenses. Over the last 5 years, the company´s interest coverage ratio has been hovering around the range of 6.7-13.5, which means that EBIT was able to cover annual interest expenses 6.7 times to 13.5 times. For reference, many analysts consider a ratio of 2 to be healthy. I don´t share the same sentiment because I like to be on the more conservative end, and I think anything over 5x is considered to be much better. I think 2x gives very little leeway for bad years of performance, while 5x allows for those years of softer sales, which end up bringing down EBIT considerably, however, if a company can already cover the interest 5 times over, it means that it may be able to cover it even in the bad years of performance. In the latest quarter, these ratios were 0.26, 0.56, and 5.4, so the company passes all the solvency ratios I deem important to decide whether the company has too much debt on its hands. It’s safe to say the company is at no risk of insolvency.
CACI´s current ratio has been okay in the last 5 years; however, I would have liked to be slightly better, at least 1.5. As of the latest quarter, it was at 1.2. Nevertheless, the company still has enough liquidity to cover its short-term obligations, however, it is a bit too close for comfort. I prefer a range between 1.5 to 2.0, which I consider efficient because it tells me the company can easily cover its ST obligations and still have enough capital for further growth of the company.
Looking at the company´s ROA and ROE, we can see that these have been quite stable over the last 5 years, with a little bump in FY21, which can be attributed solely to cost efficiencies. Cost of goods sold improved by around 90bps over FY21, however, it wasn't long-lived because the next year COGS increased by 90bps once again, which brought down the returns. The company is in a very tight-margin business, and I don't know how easily it can reduce costs. From looking at the historical figures, it seems to be very hard to improve profitability.
The same story can be seen in the company´s return on invested capital. It is not bad; however, I look for at least 10%, which tells me that the management is adept at choosing where to invest the available capital for good returns. I believe that anything over 10% ROIC has some sort of competitive advantage and a decent moat. As of FY23, the company's ROIC was around 9%, so it is just a little under what I would like to see.
If we look at the competition against CACI as per Seeking Alpha, CACI seems to be somewhere on the lower end of profitability, which isn’t the kind of company I like to invest in. The below metric from Seeking Alpha is not the same as ROIC, however, it measures profitability.
ROTC of CACI vs Competitors (Seeking Alpha)
In terms of revenues, over the last decade, the company managed to achieve around 7% CAGR, which is neither great nor very bad. The company´s guiding for around $7.3B of total sales for FY24, which is around 9%, which can be attributed to “higher-than-expected material purchases by customers”. Revenues in the latest quarter have increased 15.2% y/y, which is great, but I don’t think it´ll translate into much bottom-line improvement, because total costs of revenues increased by 16.3%. It seems that the profitability is taking a hit so far this year, and it is not certain when and if it will improve over the next quarters.
Revenue Growth of CACI (Author)
Speaking of profitability, margins have been very consistent as I mentioned earlier, however, these have been decreasing slightly in the latest quarter. Gross margins look to be lower by around 100bps since FY23, however, I take quarterly numbers with a grain of salt because they tend to fluctuate quite a bit, so I would be more interested in seeing the other quarters before saying that the company has been losing profitability because that wouldn't be fair.
Overall, it looks like the company hasn't been improving very much over the last while, which isn't an ideal investment in my opinion. If a company has no top-line growth, I would like to see the company grow through improving profitability, however, CACI seems to be not doing that either, so it is already not particularly attractive.
Comments on the Outlook
The company will be in operation for quite a while. The reason is the company´s backlog is robust. In the latest quarter, the backlog has increased by 7% y/y to $26.7B, which represents around 4 years of annual revenue. Not often do we get this much foresight into the company's operations, so it is always nice when we do. The company´s backlog has been growing steadily over the quarters 4% in Q1 ´23, 10% in Q2 ´23, 8% in Q3 ´23, and 11% in Q4 ´23. If it continues to win contracts as it has in the past, the revenue growth will stay at around the same, which isn't bad.
What I don’t like about the growing top line is the fact that the company grows its costs at a higher pace (sometimes). A significant portion of the company´s revenue comes from government agencies, and a lot of them do come with price caps , so the company has almost no say in what they can charge. This leads to lower margins overall and hard to get any efficiencies, which isn’t good for growth. The company is in a tough sector where margins are doomed to be the same constantly unless something changes, however, it is not all bad since the company is profitable and will chug along just fine. Let´s see what I would be willing to pay for the company.
Valuation
I always tend to approach my valuation analysis with a conservative mindset for that extra margin of safety. Sometimes this means that I will never own a stock because of very low valuations, but sometimes crazy things happen, and the company comes down to my PT.
For revenues, I decided to go with around 6% CAGR over the next decade for my base case, which is slightly lower than its historical average. To cover my basis, I also decided to have a conservative and optimistic case of revenues. Below are those assumptions with their respective CAGRs.
Revenue Assumptions of CACI (Author)
In terms of margins and EPS, I decided to not judge the book by its cover, I mean I won´t take the decrease of around 100bps in margins in the latest quarter to heart because, in the end, it may average out to be around the same as it was at the end of FY23. Therefore, I went with a slight improvement in margins over the next decade. Below are those assumptions.
Margins and EPS of CACI (Author)
For the DCF analysis, I decided to use 9% as my discount rate instead of the company´s WACC of 7.6%. I wanted to give myself a little more margin of safety due to the company´s lack of improving efficiency and its outstanding debt with not so much cash on hand. On top of these assumptions, I´m adding another 25% margin of safety just to give myself more room for error.
With that said, CACI´s intrinsic value and what I would be willing to pay is around $231 a share, which means it is around 30% over its fair value.
Intrinsic Value of CACI (Author)
Closing Comments
So, it looks like the company is not a good buy right now. The main concerns for me are all to do with how the company operates. Any increase in sales is followed by an equal increase in costs, which to me sounds like the company isn’t going to improve efficiency. That is not a particularly exciting company to own, however, a company may be worth the risk if it comes down to around $230 a share.
For now, I will set a price alert closer to my PT and will try to follow the next quarter's results to see how the margins develop over time, and I hope these are improving. At this price point, I don't think it is an attractive entry for a long-term investment.
For further details see:
CACI International: Margins Doomed To Stagnate Due To Governmental Contracts