Kratos Defense & Security Solutions (NASDAQ: KTOS) got a big lift Friday when investment bank Raymond James upgraded its stock from outperform to strong buy and raised its price target to $27 a share.
As of 1:22 p.m. ET, shares of the tiny defense contractor were up by about 7.5%.
What Raymond James is saying about Kratos
The reason for the upgrade was obvious: "Drones & Air Defense ... demand has accelerated with the ongoing and escalating conflicts globally," wrote analyst Brian Gesuale. What's more, the conflicts in Ukraine and Israel are giving rise to rapid advances in both drone and missile defense technology.
This has two implications for Kratos. First, "Kratos provides content on most of the major western air defense systems," and as interceptor missiles are expended in defense, Kratos will generate recurring revenue as it restocks them, wrote Gesuale. Furthermore, he asserted, "we are in the very early stages of a generational upgrade to Air Defense systems globally." Longer term, this will provide an opportunity for Kratos to sell increasingly more drones, missiles, and missile parts as nations expand their defense capabilities.
Is Kratos Defense stock a buy?
The big questions are how much growth Kratos can expect to capture from these trends -- and whether that potential justifies buying Kratos stock at its current price. It's not clear that it does.
Growth is great and all, and most analysts who follow Kratos expect the company (which is currently losing money) to turn profitable this year, and then triple its profits over the next three years. That being said, Kratos is a $2.6 billion market cap company with about $250 million in debt. But it generated less than $7 million in free cash flow last year, and lost money on a GAAP (generally accepted accounting principles) basis. At best, it's expected to generate between $46 million and $47 million in profit and FCF in 2026. That would give it a valuation multiple of about 60 times profits that it hasn't even earned yet.
While the stock could perform brightly, that valuation looks too rich for me.
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Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
