2023-05-31 23:09:26 ET
Summary
- CACI International Inc. is a critical provider of expertise and cutting-edge technology to both enterprise and mission customers, with a specific focus on supporting national security and government modernization efforts.
- CACI reported strong Q3 FY2023 results with organic revenue growth of 10% and adjusted EBITDA margin of 11% [vs. 10.2% last year].
- Assuming a relatively modest 17-18x FY2024 P/E with an EPS of $20.15, the stock should trade at ~$342.55 [mid-range] at the end of 2024, a 14.1% underestimate.
- Since the undervaluation I calculated is below 15% - the minimum threshold for a "Buy" rating in my valuation system - I rate CACI stock a "Hold" this time around.
The Company
CACI International Inc. ( CACI ) is a critical provider of expertise and cutting-edge technology to both enterprise and mission customers, with a specific focus on supporting national security and government modernization efforts. On the enterprise side, CACI's capabilities bolster the internal operations of government agencies through specialized services such as functional software development, data & business analysis, and IT operations support. CACI's technology services extend to both customer types, employing advanced methodologies and tools such as large-scale software development using modern open architectures, DevSecOps, agile methodologies, advanced data platforms, and AI-driven multi-source analysis. This suite of services spans network and IT modernization, commercial solutions for classified information, cyber security active defense, and the customization and maintenance of various commercial-off-the-shelf and ERP systems.
According to the latest 10-Q filing for Q3 FY2023, CACI reports operating results and financial data in 2 segments: Domestic operations and International operations, generating the vast majority of revenue and profit in the United States:
Obviously, the international sales segment has a higher bottom line margin than the domestic one - this is confirmed by the lower EURUSD exchange rate, which couldn't prevent this segment from looking more resilient in the third quarter of FY2023 [this is because when they convert their revenues from Euros to Dollars, they would receive fewer Dollars per Euro due to the lower exchange rate].
It's hard to say why the marginality of the international segment looks better. Perhaps it's because this segment exclusively serves the corporate world and receives no revenue from cost-plus-fee contracts. In any case, it's important to understand this in order to assess the future of the company - how actively CACI's management will seek to shift its focus to international sales is likely to determine future earnings per share growth, which is very important to potential and current shareholders.
The total addressable market is estimated by management to be ~$260 billion, which is a lot for a $6.8 billion market cap company. But this addressable market is quite populated and has multiples of players and thus fierce competition. If we narrow the scope and focus on the defense IT spending market, the global defense spending market is expected to grow at a CAGR of 4.38% through 2027, according to Fortune Business Insights . I think CACI will continue to get a piece of this growing pie for the foreseeable future - the company's organic growth should slightly outpace market growth.
As for actual results, CACI reported strong Q3 FY2023 results with organic revenue growth of 10% and adjusted EBITDA margin of 11% [vs. 10.2% last year].
The book-to-bill ratio for the last 12 months remained stable at 1.4x. As we know from theoretical finance , a book-to-bill ratio of greater than 1 indicates that demand is higher than supply, implying that more orders were received than could be filled, suggesting strong future business. And this finding is confirmed by the management's words during the latest earnings call , where the CEO mentioned an ongoing demand in several significant areas including application and network modernization, cloud migration, photonics and situational awareness in the Space domain, and software-defined Signals Intelligence and Electronic Warfare within the Electromagnetic spectrum.
CACI's major wins included a contract with the United States Air Force for Enterprise-IT-as-a-Service (EITaaS), the largest contract award in the company's history, and the successful roll-out of the latest version of the Army's Integrated Personnel and Pay System (IPPS-A), the largest and most complex PeopleSoft implementation, serving over a million soldiers.
Additionally, in the Space domain, CACI is advancing its photonics technology, which enables secure space-based communications networks, and it continues to be a major provider of sensing systems across all domains. CACI has been able to update capabilities faster due to its software-defined technology, exemplified by an over-the-air software upgrade of an operational system on a Navy ship at sea.
Following these strong results, CACI raised its fiscal 2023 revenue and earnings guidance:
The company faces headwinds on its FCF generation because of the previously announced tax method change - this year will be the largest cumulative headwind they experienced for these 3 items, CACI's CFO noted during the earnings call. But it didn't stop the Board from authorizing a $750 million share repurchase program. As of the end of Q3 FY2023, they already repurchased an additional 45,000 shares in the open market at an average price of about $283. They should continue the program until the end of the year, judging by the forecast of the number of shares outstanding.
Buybacks, however, aren't all that should give prospective buyers a reason to buy CACI.
Valuation & Expectations
For starters, I suggest looking at forwarding FCF yield based on the management's guidance. Let's assume the company actually generates $280 million by the end of FY2023 - then the current FCF yield would fall to 4.1%, even below the low of 4.18% since 2005:
By itself, this is a bad sign for investors - they receive less potential FCF per 1 share purchased. However, as we can see from the chart above, this downward trend has continued since 2015. So trying to wait for that average FCF yield of 9.83% would have resulted in an opportunity cost of 248% of the total return of CACI since 01/01/2015 if we take specifically that period for comparison:
If the growth of CACI's stock isn't due to free cash flow, then it could be primarily due to multiple expansion. In other words, the increase in CACI 's stock price could be primarily due to an increase in the valuation multiples that investors are willing to pay for earnings or other financial metrics, rather than an increase in the company's fundamental performance.
Right now, the forwarding P/E ratio of CACI stock is roughly at its long-term average since 2003, a period that has seen both multiple contractions through the middle of the last decade and multiple expansions over the last 10 years. In the first case, the stock almost didn't move, or in other words, the company needed more time to grow out of its valuation. But when the multiple increased, the stock reacted much faster and more positively. I don't expect CACI to return to its previous low multiples for the foreseeable future - this is hindered by the ongoing buyback program, which artificially inflates valuation by reducing available float. If so, the long-term P/E of ~15.5x shouldn't make practical sense - we should aim for higher values.
But the market doesn't agree with me and there is a reason for that - the maturity of the business.
As you can see above, analysts are assuming multiple contraction as CACI becomes a more mature company. However, you have to understand that CACI is already not a fast-growing company - the projected revenue growth of 7-9% in FY2023 confirms this. The market expects EPS growth to drop to 3.56% [FY2023], but then recover to 9.23% in FY2024. Let's assume they're right. Will management then refuse to expand the buyback program? I highly doubt it. Accordingly, there's no reason to believe in multiple contracting much from here if you ask me. Assuming a relatively modest 17-18x FY2024 earnings multiple [ today it's at 19x ], with an EPS of $20.15, the stock should trade at ~$342.55 [mid-range] at the end of 2024, a 14.1% underestimate.
The Verdict
Since the undervaluation I calculated is below 15% - the minimum threshold for a "Buy" rating in my valuation system - I rate CACI stock a "Hold" this time around. CACI International looks quite solid - the growth prospects are indeed there with such a strong backlog and the existing pipeline of submitted bids:
The continued growth of CACI stock by another 30-50% is largely dependent on the continuous expansion of its valuation multiples. However, relying on this presumption without having great confidence in the company's organic growth can be quite risky. This is especially important for potential investors. While current shareholders may already be benefiting from the stock's performance, those considering an entry investment should wait for a 10-15% correction in current prices, in my view. The associated upside risk is reminiscent of the situation ten years ago when the greatest risk was missing a potentially profitable opportunity.
Thanks for reading!
For further details see:
CACI International: Strong Company, But Already Fairly Valued