When defense contracting company Leidos Holdings (LDOS -0.84%) reported its earnings for the first fiscal quarter of 2022 on Monday, I have to say the numbers didn't look great. Sales grew only 5% year over year, profit margins shrank, and Leidos's earnings declined by 12%.
The numbers didn't look great...but they could soon look a whole lot better.
Image source: Getty Images.
Less profit! Hurray?
Single-digit sales growth and falling profits aren't ordinarily what investors want to hear from their companies. And yet, two days after earnings came out, Leidos shares are actually up a bit more than 1% on the news.
Does that make sense?
Well, consider: Leidos earned less money on its sales this past quarter than it did a year ago -- a net profit margin of just 5.1%. Earnings were only $1.25 per share, down by the aforementioned 12%, and free cash flow for the quarter -- real, cash profit -- was a mere $65 million, or barely one-third of reported net profit. And yet, none of these were the most startling numbers at Leidos in Q1.
Instead, the big news was that in Q1, the company landed a $2.5 billion telecommunications and cloud computing contract with NASA; a $1.7 billion air traffic control contract with the Federal Aviation Administration; another $1.7 billion contract from the Veterans Benefits Administration; and over $400 million total in contracts from the U.S. Navy and the U.S. Army.
In total, Leidos says it collected "net bookings" worth $5.4 billion in the quarter -- and maybe more than that. (By my math, $2.5 billion plus $1.7 billion plus $1.7 billion plus $0.4 billion adds up to $6.3 billion.) And compared to the $3.5 billion in sales Leidos billed in the quarter, that works out to a 1.6 "book-to-bill" ratio for Leidos. In other words, for every $1 in sales Leidos executed in the quarter, it took in $1.60 in new work to be done.
Suffice it to say that this is extremely bullish for future sales growth at Leidos. It implies that sales, and presumably profits (if the company can inch up that profit margin a bit) will be growing strongly in future quarters and years.
Underpromise, overdeliver
Granted, many of these contracts are long-term in nature -- as long as 10 years -- so it may take some time for the money to roll in. In the near term, Leidos is still being conservative on guidance, and simply affirming prior predictions that it will collect between $13.9 billion and $14.3 billion in sales this year, earn "non-GAAP" (adjusted) profits between $6.10 and $6.50 per share, and generate in excess of $1 billion in cash from operations.
Even at the low end of guidance, though, that values Leidos at a below-market 17.2 times earnings -- and maybe even cheaper, if Leidos per-share earnings are closer to $6.50 than $6.10 this year. I call that a bargain.
