Building rockets is hard. Building rockets and launching them reliably into space is even harder. Only one private company has managed to do this at scale, SpaceX, with its huge reusable rockets and landing pads. That is until Rocket Lab(NASDAQ: RKLB) joined the party. Nipping at SpaceX's heels, Rocket Lab has built a successful niche in the space economy and is now the second private space flight company to consistently and reliably launch payloads into orbit.
Unlike SpaceX, Rocket Lab is a publicly traded company that anyone with a brokerage account can invest in. The company reports its third-quarter earnings on Nov. 12, and investors will be looking for more revenue growth, product developments, and improved profitability across its operations. Should you buy the stock before this third-quarter earnings release?
Embracing the future of space flight
Rocket Lab is taking advantage of the booming space economy, which analysts estimate will have over $1 trillion in annual spending within the next 10 years. Capturing value in the space supply chain begins with launching rockets into space. Rocket Lab is the second private company alongside SpaceX to reliably launch rockets into orbit for commercial customers, starting with its small Electron rocket.
The company generates direct revenue from launch contracts. More importantly, it leads to contracts that come on top of the actual launch, including building space systems, capsules, and satellites for customers. These customers are the United States government and private companies such as Synspective. Given the minimal competition in small rocket launches, Rocket Lab has built up quite the backlog for its launch and space systems segments, totaling over $1 billion last quarter.
In the long term, Rocket Lab wants to add a third pillar to its business: space data and software services. Like SpaceX and its Starlink satellite internet service, Rocket Lab plans to offer high-margin software services thgough its space infrastructure. This is where the true profit potential may lie in the company's business model because, frankly, it is highly unprofitable today.
Neutron progress and margin expansion
The company has never generated a profit or positive free cash flow, so it is not surprising that some investors shy away from Rocket Lab stock. Over the last 12 months, it has burned $149 million in free cash flow. With only around $500 million in cash on the balance sheet, the company needs to get profitable within the next three years or go to the capital markets to raise more funds. Either way, it is a concern for shareholders.
This does not mean its current rocket launches with the Electron are unprofitable, though. A lot of Rocket Labs' expenses come from upfront investments to fulfill its huge customer backlog along with the development of the large Neutron rocket. The Neutron is going to be a much larger rocket than the Electron, which means it will generate much more in revenue for each payload it launches into orbit. Last quarter alone, Rocket Lab spent around $40 million on research and development, or 38% of its revenue. As the company scales its operations, this spending as a percentage of revenue should come down.
RKLB Revenue (TTM) data by YCharts
Should you buy the stock?
Investors considering adding Rocket Lab to their portfolios need to ask themselves a simple question: How risk-tolerant am I? Because Rocket Lab stock comes with a lot of risk. It also comes with a lot of upside potential.
At the current market cap of $5.3 billion, the stock trades at more than 10 times its trailing-12-month sales of $327 million, and its profits are nonexistent. There is a good chance that Rocket Lab will be unprofitable for the next three to five years or longer. That would put some pressure on the stock.
The upside comes from its huge and growing backlog of $1 billion along with the clear development pipeline it has laid out for investors. It wants to keep building its rocket launching capabilities with the Neutron, add more to its space hardware division, and eventually launch data services to sell to customers. With $1 trillion set to be spent each year on the space economy, Rocket Lab has a chance to eventually generate billions in annual revenue with a huge competitive advantage (that advantage being one of the only companies able to safely launch rockets into orbit).
If you are comfortable buying a stock with a lot of downside, you can go ahead and buy shares before its next earnings report. If not, it is best to keep this one out of your portfolio.
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Brett Schafer has no position in any of the stocks mentioned. The Motley Fool recommends Rocket Lab USA. The Motley Fool has a disclosure policy.
