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KBR’s (NYSE:KBR ) stock has seen a sharp rally, rising ~20% from the mid-40s to mid-50s, over the last few weeks. The company’s good order growth last quarter and its defence exposure served as a catalyst for the stock. The company’s sustainable technology segment has a significant exposure towards ammonia production technology and the company is benefiting from rising fertilizer prices. Its government segment should also benefit from a potential increase in defence spending due to the recent geopolitical developments. Management has given a target of $4 to $6 in EPS by FY2025 which, at the midpoint, is more than double the FY2021 EPS of ~$2.42. I believe the stock can see further upside from the current levels.
KBR reported mixed results with net revenue of $2.5 billion in Q4 2021 (up 71.5% year over year), which was slightly lower than the consensus estimate of $2.53 billion. The adjusted EPS for the period increased 35.3% year over year to $0.69 (vs. $0.65 consensus estimate), up from $0.51 the Q4 2020. Adjusted EBITDA increased 27.4% year over year to $172 million from $135 million in the previous year's same period. KBR's participation in the US government's OAW (Operation Allies Welcome) program increased revenue and profit in the Government Services (GS) business for the full year 2021, whereas the Sustainable Technology Solutions (STS) business saw a slight decrease in revenue as they wind down projects related to legacy energy solutions as part of their restructuring plan.
KBR Segment Performance (Company Data, GS Analytics Research)
In terms of bookings and backlogs, KBR’s Government Service business reported a healthy book to bill ratio of ~1.3x in the fourth quarter helped by the strength in new orders related to defence, space and cyber security markets. For the year 2021, the company won ~$6.7 bn in new orders in the Government services business.
On the sustainable technology side, KBR was able to win almost all of the greenfield awards it bid on in 2021 with bookings across the green, blue and grey ammonia landscape. The strong demand in this segment was driven by the fertilizer end market which is benefiting from rising prices. The book-to-bill ratio for this segment was ~1.1x in the fourth quarter of 2021, and the total booking for the year totalled ~$1 billion. The rise in demand for sustainable technology, as well as the US government's proposed Infrastructure Act, should help drive pipeline growth for this segment.
The Government Services division accounts for nearly 70% to 80% of total revenue. Defence and Intelligence, which is a part of this business, contributes about a quarter of the revenue generated by the GS business. The US defence spending budget for FY2022 is ~$770 bn and will likely increase further next year. I believe the recent geopolitical developments with Russia invading Ukraine will instill a sense of urgency to increase the defence spending among the U.S. and its allies like the U.K. and Australia. This bodes well for KBR.
Government Service revenue distribution in FY21 (Company Data, GS Analytics Research)
Aside from defence spending, the unapproved fiscal 2022 non-defence discretionary spending proposal includes a 16% increase in funding, including a 6.5% increase in funding for NASA to support the continuation of scientific research and exploration as well as increased funding across all agencies to tackle climate change. In 2021, Space & Science end market accounted for ~16.5 percent of the company’s Government Service business. So, the project pipeline for this business is also expected to remain healthy.
With defence and civil budgets driven in part by political instability, military conflicts, ageing platforms and infrastructure and the need for technology advances, the long term outlook of the company’s Government Service segment looks positive. On the Sustainable Technology side, the growth in the fertilizer market should help the company meet its target of double-digit growth in the segment’s revenue. The company saw an increase in ammonia technology demand, primarily in the second half of 2021 (as reflected in their awards for the period), and management expects it to continue to rise in the future. In the long term, the company is also well-positioned to benefit from any advances in the use of green Ammonia technology. KBR has a global market share of more than 50% in ammonia technology, which positions it well to benefit from any increase in Ammonia demand.
Aside from organic growth, the company has been strategically expanding its business through mergers and acquisitions. The company acquired Centauri in October 2020 and Frazer Nash in October 2021. The Centauri acquisition should help them scale their military and intelligence business, whereas Frazer Nash will add to the company’s professional advisory services. The presence of Frazer Nash in the United Kingdom and Australia will also help the company expand their international footprint.
The company’s long term prospects look good and management has given a FY2025 EPS target of between $4 and $6 helped by good execution, strong fundamentals, robust backlog and a positive outlook about the project pipeline. This was before the Russia Ukraine war started. The outlook of defence spending should improve after the recent geopolitical developments. So, the company's chances of meeting its target have also improved.
There is another positive development which has happened in the recent days. The US Armed Forces, DoD civilians, and their families use HomeSafe Alliance, a KBR joint venture, to manage the shifting of their household goods. In November of last year, the US Transportation Command (TRANSCOM) awarded the Global Household Goods Contract (GHC) to HomeSafe Alliance. The TRANSCOM contract has a ceiling value of approximately $20 billion over nine years. ARC and Connected Global Solutions, two bidders, had filed a protest with the Government Accountability Office against this award (GAO) . The GAO recently announced that the protests filed by these companies were dismissed because they lacked merit. This project won’t impact the company’s results much in FY2022, but once it starts to ramp up in FY2023, the company’s top and bottom-line should benefit meaningfully.
KBR is currently trading at ~$21.65x FY22 EPS. Before the stock saw a significant jump on the news of the Russian invasion of Ukraine, it was trading in the mid-40s at ~17.5x FY22 consensus EPS estimates. Even if we are conservative and assume the company can reach the low end of its EPS target range and post $4 in EPS, using 17.5x P/E gives us a target price of $70 (or ~27% upside from the current levels). In the base case, if the company can reach the midpoint of its target range or $5 in EPS, using a 17.5x P/E will give us a target price of $87.5 (or ~58% upside). So, I believe there is further upside possible for the stock.
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.