We are initiating coverage of a provider of technology and engineering services to defense, intelligence, homeland security, and healthcare customers, notes Stephen Biggar of Argus Research, a leading independent investment research firm.
Although Leidos Holdings (LDOS) operates in a highly competitive field, we view its recent merger with the Information Systems & Global Solutions unit of Lockheed (LMT) favorably, as it reduces the combined company’s dependence on government contracts.
The acquired Lockheed business — which provides a range of IT infrastructure, facility maintenance, and logistics services — has a larger proportion of non-military and commercial customers than Leidos, and should also provide significant revenue and cost synergies.
LDOS is trading at just 12.9-times our 2017 EPS forecast, well below the average of 20.5 for peer IT services companies.
Although we expect slower growth at Leidos than at peers in the near term, we believe that the nearly 40% valuation discount is excessive given the company’s improving outlook.
In particular, the recent combination with Lockheed’s IT division should provide Leidos with substantial cost savings and a better revenue mix.
The company pays a quarterly dividend of $0.32 per share, or $1.28 annually, for a yield of about 3.1%. It also paid a special dividend of $13.64 per share in August 2016 in connection with the Lockheed transaction.
We initiate coverage of the stock with a buy rating. Our target price of $54 implies a multiple of 16.9-times our 2017 EPS estimate, and a more reasonable discount to peers. Including the dividend yield, our target implies a total potential return of 33% from current levels.
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By Stephen Biggar of Argus Research
