Summary
- Shares of Parsons have done quite alright this year, as investors have priced in benefits from increased political tensions and related to that defense spending.
- While sales momentum is improving and deleveraging is delivered upon, earnings growth is a bit lackluster.
- Overall valuations remain too steep for me, despite some near to medium term tailwinds.
In May of this year I noted that shares of Parsons ( PSN ) were getting in defense mode. The company has seen lackluster performance in 2020 and 2021, yet renewed political tensions should drive results in the future, although execution is needed to deliver on this.
We have seen a more resilient performance ever since, yet the market has priced in these advancements aggressively, too aggressive to my taste.
Defense
Parsons is a provider of technology-driven solutions for defense, intelligence and infrastructure markets. The company helps clients with design, engineering, servicing and software in order to keep the world smart, connected and safe.
The company went public at $27 in 2019 as Parsons generated $3.95 billion in sales at the time on which GAAP earnings of $120 million were posted, equal to $1.30 per share, albeit that adjusted earnings came in a bit higher. Shares rallied to the mid-thirties in 2020 as realistic earnings improved to a run rate of around $2 per share, with net debt approximating reported EBITDA.
The company did end up posting a 1% fall in 2020 sales to $3.90 billion with adjusted earnings per share down fourteen cents to $1.90 per share, albeit that the reconciliation to GAAP earnings looked fair, and the balance sheet was further deleveraged. Sales were seen flattish in 2021, with a backlog increasing to $8 billion (equal to two times sales), as earnings should be rather flat.
As it turned out, 2021 sales did fall to $3.66 billion, a meaningful shortfall compared to the initial outlook and the 2020 performance as earnings fell all the way back to $1.65 per share. If we adjust for a $20 million stock-based compensation expense, earnings even fell short of the $1.50 per share mark. This lackluster performance made it easy to understand why shares fell to the $30 mark as the 2022 guidance was not convincing, with sales seen at $3.8 billion. Adjusted for a deal announced during 2021, that outlook hardly any organic revenue growth to be expected.
The stock came to life nonetheless, having rallied from $30 at the start of 2020 on the back of the situation described above, to $40 following the outbreak of the war in Russian and Ukraine. Moreover, the company announced a $400 million deal to acquire Xator, and it posted solid first quarter results. The Xator deal was set to push up net debt to $700 million, equal to about 2 times EBITDA with realistic earnings likely trending at $1.75 per share. With the tailwind of the war still having to play out I was a bit cautious.
Holding Up Well
In choppy markets, shares of Parson have risen from $40 in the spring to $45 at the moment writing, marking decent outperformance versus the wider markets. The company closed on the Xator deal on the first day of June, hence the deal was included (partially) in the second quarter results. The company raised the full year sales outlook to a midpoint of $4.05 billion, up a quarter of a billion following solid organic performance and the purchase of Xator. The EBITDA guidance was hiked by fifteen million to $345 million. Net debt of $667 million was below the pro forma $700 million number seen at the time of the Xator purchase.
Following more contract wins during the second half of the year, the company posted another set of strong third quarter results early in August. Revenues rose 19% to $1.13 billion, driven by an 11% increase in organic sales. Profitability metrics rose quicker than sales and the book-to-bill ratio exceeded the 1 times metric, pushing up the backlog to $8.2 billion.
This made that the company hiked the midpoint of the full year sales guidance by $75 million to $4.125 billion with the midpoint of the EBITDA guidance hiked by $5 million to $350 million. Net debt has fallen to $547 million, rapidly reducing leverage ratios to around 1.5 times. The issue is that adjusted earnings are only up 19 cents to $1.29 per share in the first three quarters and with the fourth quarter typically a bit strong, I peg a roadmap for earnings around $1.90 per share.
This is still quite high with shares now up to $45, translating into a 23-24 times earnings multiple. Moreover, equity-based compensation is excluded in these numbers, to the tune of about $0.15 per share. Adjusted for this, earnings come in around $1.75 per share, pushing up realistic earnings multiples to 25–26 times as well.
Not Involved
While I am somewhat happy to see improved operating performance in terms of sales growth and deleveraging so far this year, the earnings numbers remain complicated and tough.
All of this makes me a bit cautious here as earnings multiples have risen to 15 times earnings, with shares having done quite well so far this year, outpacing the actual revenue growth as increased political tensions still really have to show up in more organic growth and an increase in the backlog.
Given these discussions, the promise or Parsons has been priced in and while some green shoots are seen, the overall valuation looks too rich to see appeal here.
For further details see:
Parsons: Not Very Defensive