The past six months have been a windfall for Kratos’s shareholders. The company’s stock price has jumped 155%, hitting $84.10 per share. This was partly due to its solid quarterly results, and the performance may have investors wondering how to approach the situation.
Is now the time to buy Kratos, or should you be careful about including it in your portfolio? Get the full stock story straight from our expert analysts, it’s free for active Edge members.
Why Is Kratos Not Exciting?
We’re happy investors have made money, but we're sitting this one out for now. Here are three reasons we avoid KTOS and a stock we'd rather own.
1. Free Cash Flow Margin Dropping
Free cash flow isn't a prominently featured metric in company financials and earnings releases, but we think it's telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
As you can see below, Kratos’s margin dropped by 6.7 percentage points over the last five years. Almost any movement in the wrong direction is undesirable because it is already burning cash. If the trend continues, it could signal it’s becoming a more capital-intensive business. Kratos’s free cash flow margin for the trailing 12 months was negative 5%.
2. Previous Growth Initiatives Haven’t Impressed
Growth gives us insight into a company’s long-term potential, but how capital-efficient was that growth? Enter ROIC, a metric showing how much operating profit a company generates relative to the money it has raised (debt and equity).
Kratos historically did a mediocre job investing in profitable growth initiatives. Its five-year average ROIC was 3.4%, lower than the typical cost of capital (how much it costs to raise money) for industrials companies.
3. New Investments Fail to Bear Fruit as ROIC Declines
A company’s ROIC, or return on invested capital, shows how much operating profit it makes compared to the money it has raised (debt and equity).
We like to invest in businesses with high returns, but the trend in a company’s ROIC is what often surprises the market and moves the stock price. Unfortunately, Kratos’s ROIC averaged 4.9 percentage point decreases over the last few years. Paired with its already low returns, these declines suggest its profitable growth opportunities are few and far between.
Final Judgment
Kratos isn’t a terrible business, but it doesn’t pass our bar. Following the recent rally, the stock trades at 129.6× forward P/E (or $84.10 per share). This valuation tells us a lot of optimism is priced in - you can find more timely opportunities elsewhere. Let us point you toward an all-weather company that owns household favorite Taco Bell.
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