One of the cheapest stocks in our All Investable – Stock Screener is Vectrus Inc (NYSE:VEC).
With a market cap of $240 million, this micro-cap remains undiscovered by a lot of investors and too small for investment by large institutions.
Vectrus provides infrastructure asset management, information technology and network communication services, and logistics and supply chain management services to the U.S. government worldwide. Its main business is providing base operations, logistics, information and communications services to the military.
A quick look at the company’s share price (below) over the past twelve months shows that the price is up 12% to $22.36 from $20.53 in March 2016. That is 36% off its 52 week high of $34.98.
(Source, Google Finance)
Vectrus had two major setbacks in 2016 which were reflected in the significant share price drops in September. The first was the Army’s non-renewal of the company’s (APS-5 Kuwait) contract to provide services in Qatar and Kuwait, and the second was the loss of its Kuwait Base Operations & Security Support Services (K-BOSSS) contract, which was the largest contract in the Vectrus portfolio. Vectrus subsequently re-competed on both contracts (see below).
Latest Earnings Release
Vectrus recently released its Q4 2016 and FY2016 results. FY2016 revenue was up 1% to $1.19 Billion compared to $1.18 Billion for the previous corresponding period (pcp). The increase was due mainly to a $130.9 million increase in revenue from the company’s Middle East programs. Operating income was also up 3.6% to $42.8 million from $40 million compared to the pcp, and EBITDA improved by 5% to $45 million from $43 million for the pcp. The net result was that Vectrus reported a 22% drop in net income of $24 million compared to $31 million for the pcp.
K-BOSSS Update
Just this month Vectrus was informed that the U.S. Government has cancelled the solicitation for the K-BOSSS re-compete. According to the notification received by Vectrus, the U.S. Government determined the requirements under the solicitation have changed substantially because of change in mission requirements. The U.S. Government anticipates soliciting the new K-BOSSS requirements as soon as practicable.
“We recognize the Government’s concerns and look forward to a new solicitation,” said CEO Chuck Prow. “Meanwhile, we will continue to deliver the excellent performance our client has consistently received on this contract.”
In 2016, the K-BOSSS program contributed approximately $438 million or 37% of Vectrus’ revenue.
“Our full-year 2017 guidance, issued on Mar. 1, 2017, anticipated an extension of our existing K-BOSSS contract and contribution well into the third quarter of 2017,” said Matt Klein, chief financial officer of Vectrus. “At this point, we are not changing 2017 guidance, until we receive additional contracting direction on the existing contract.”
Vectrus had stated in its latest earnings report that its 2017 revenue would be in the range of $910 million to $1 Billion, including an anticipated extension of its K-BOSSS contract.
APS-5 Update
Regarding the company’s re-compete on the APS-5 contract Vectrus stated that on December 21, 2016, the GAO issued its decision denying Vectrus’ protest of the APS-5 contract award. The company is currently proceeding with its program phase out. In 2016, the APS-5 Kuwait contract contributed approximately $181 million, or 15% of revenue for Vectrus and is extended through March 2017.
New Contracts
In spite of the loss of the APS-5 contract and new solicitation of its K-BOSSS contract it’s important to note that during 2016 the company was awarded and has successfully phased in $21 million in installation services in the past quarter in support of the U.S. Air Force at Al Udeid Air Base in Qatar. The task order was awarded under the Air Force Contract Augmentation Program, indefinite-delivery/indefinite-quantity, or IDIQ contract also known of AFCAP, which provides full spectrum logistics and base operations support.
Additionally, during 2016 Vectrus was also awarded a position on the U.S. Navy’s Global Contingency Services multiple award contract II known as GCS MAC II, which has an eight-year duration. Work on GCS MAC II will include short notice facility support services and infidel construction and support of natural disasters, military efforts, and humanitarian support for the Defense Department and other customers around the world.
The GCS MAC II contract represents the second long-term IDIQ win in support of global contingency effort. While opportunities associated with GCS MAC II are difficult to forecast, given its contingency-based nature, Vectrus said it is pleased to be part of the effort and looks forward to providing the Navy with its differentiated and robust solutions.
In 2016, Vectrus was also awarded the Enterprise Legacy Voice and Information Systems contract or ELVIS, which is an IT contract it has supported for almost 20 years. While ELVIS represents a small percentage of total revenue it is an important strategic contract that provides integrated and reliable command and control intelligence and deployable communications support to manned and unmanned air force sites in Belgium, Germany, the United Kingdom, and Turkey.
More recently, in 2017, Vectrus announced that it had been awarded another AFCAP task order in the amount of $14 million to provide installation services at Bagram Airfield in Afghanistan. CEO Chuck Prow said, “We look forward to continuing to compete for task orders under AFCAP and supporting our client’s contingency mission. As a reminder, the AFCAP contract was awarded in June of 2015, it has an estimated completion date of September 2021.”
It’s also important to note that during the fourth quarter, Vectrus was awarded a modification to its existing Maxwell Base Operations Support contract that extend its propellant period into May. Vectrus expects the Air Force to award this re-compete contract in the second quarter of 2017.
There’s also the $411 million seven year Thule Base Maintenance Contract which the Air Force awarded to a Danish subsidiary of Vectrus in October of 2014. After a lengthy protest and litigation period, on December 14, 2016, the Air Force directed Vectrus’ Danish subsidiary to begin the transition of the two-week contract. The Danish subsidiary of Vectrus has begun the phase-in period with full contract operations to begin October 1, 2017.
These contracts clearly highlight Vectrus’ ability to compete, re-compete and win new major military contracts.
Pipeline
In addition to the company’s successful re-competes and new business awards Vectrus currently has approximately $1.5 billion in bids submitted pending award. Additionally, the company has plans to submit a proposal of almost $6 billion of identified opportunities over the next twelve months all of which are for new business.
In terms of new business Chuck Prow said, “I believe there are several opportunities to strengthen our pipeline, while improving the overall probability of win. The Vectrus team has done a phenomenal job of managing the business through a challenging 2016. Our teams focus on cash collections and methodical approach to capital allocation resulted in a favorable financial position from a liquidity and leverage perspective.”
To summarize, in addition to all of the new contracts awarded in 2016 the company has the full contract operations set to begin later in the year on the Thule Base Maintenance Contract and a pending award on the Maxwell Base contract. Vectrus also has a prospective pipeline of $1.5 billion in bids submitted pending award, and plans to submit a proposal of almost $6 billion of identified opportunities. Add to this the company’s total backlog of $2.4 billion and a funded backlog of $665 million, and Vectrus is well positioned to replace lost revenues from its K-BOSSS and APS-5 contracts.
(Source, Company reports)
Debt Reduction
What sometimes gets overlooked about Vectrus is just how well the company has been run in terms of its capital allocation since its spin-off from Exelis in September of 2014.
One example of this is that the company ended 2016 with total debt of $85 million. That is a 39% or $55 million reduction in debt from September 2014. This included $15 million of voluntary prepayments in 2016 and $12 million in 2015.
(Source, Company reports)
“We have prudently managed our debt profile to ensure we remain below our covenants, especially given the recent dynamics involving our business,” said Matt Klein CFO. “As of year-end, we were tracking well below our 2016 debt-to-EBITDA covenant level of 3.25 times. In 2017, this covenant steps down to 3.0 times. We will continue to methodically manage our leverage profile and capital structure as we move through 2017.”
Loads of Free Cash Flow
Something else which tends to get overlooked is Vectrus’ ability to generate significant amounts of free cash flow. This is where I see the real value of the company.
A quick look at the company’s annual cash flow statements below shows Vectrus’ excellent track record in generating free cash flow since the spin-off from Exelis in September of 2014. The company generated $37 million (ttm) in operating cash flow for FY2016. At the same time, Vectrus had just $1 million (ttm) in capex, which equates to $36 million (ttm) in free cash flow for FY2016. With a current market cap of $240 million that means the company has a FCF/Price yield of 15% (ttm). The true value of the company is further realized when we consider the company’s balance sheet.
| Fiscal Period (Amounts in Millions) | Dec16 | Dec15 | Dec14 | Dec13 |
| Net Income | 24 | 31 | 23 | 84 |
| Cash Flow from Operations | 37 | 19 | 43 | 93 |
| Purchase Of Property, Plant, Equipment | -1 | -1 | -4 | -2 |
| Net Issuance of Debt | -29 | -23 | 137 | — |
| Free Cash Flow | 36 | 18 | 39 | 90 |
(Source, Company reports)
Strong Balance Sheet
Vectrus has been very prudent with its free cash choosing to pay down its outstanding debt. A quick look at the company’s balance sheet ending December 2016 below shows that Vectrus has cash and cash equivalents of $48 million and total debt of $85 million, which is easily manageable with free cash flow of $36 million (ttm).
| Fiscal Period (Amounts in Millions) | Dec16 |
| Cash, Cash Equivalents, Marketable Securities | 48 |
| Current Portion of Long-Term Debt | 16 |
| Long-Term Debt | 68 |
(Source, Company Reports)
Valuation
In terms of Vectrus’ valuation. If we subtract the $48 million in cash and cash equivalents from total debt that leaves net debt of $36 million. With the company’s current market cap of $240 million that means Vectrus has an Enterprise Value (EV) of $276 million, and with $36 million in free cash flow (ttm), that means Vectrus has a FCF/EV Yield of 13%.
We favor EV over market capitalization as it includes additional liabilities–like debt, preferred equity and non-controlling interests–if you were to purchase the entire company. EV is calculated as:
Market Cap + Preferred Equity + Non-Controlling Interests + Total Debt – Cash and Equivalents.
With an Enterprise Value (EV) of $276 million and Operating Earnings* of $46 million (ttm), that means Vectrus is currently trading on an Acquirer’s Multiple of 6.11 or, 6.11 times Operating Earnings*.
The Acquirer’s Multiple is defined as:
Enterprise Value/Operating Earnings*
*We make adjustments to operating earnings by constructing an operating earnings figure from the top of the income statement down, where EBIT and EBITDA are constructed from the bottom up. Calculating operating earnings from the top down standardizes the metric, making a comparison across companies, industries and sectors possible, and, by excluding special items–income that a company does not expect to recur in future years–ensures that these earnings are related only to operations.
With a FCF/Price Yield of 15% (ttm), a FCF/EV Yield of 13% (ttm) and an Acquirer’s Multiple of 6.11, or 6.11 times Operating Earnings*, that places Vectrus squarely in undervalued territory.
Summary
There’s no question that Vectrus has had a couple of major setbacks in 2016 with the loss of its K-BOSSS contract, estimated to be worth $438 million, and the loss of its APS-5 contract, which contributed approximately $181 million.
However, Vectrus has won a number of new contracts in 2016 and is set to begin full contract operations later in the year on the $411 million seven year Thule Base Maintenance Contract. The company is also waiting for the pending award on the Maxwell Base re-compete, and has a prospective pipeline of $1.5 billion in bids submitted pending award, and plans to submit a proposal of almost $6 billion of identified opportunities.
When you add this to the company’s total backlog of $2.4 billion and a funded backlog of $665 million, Vectrus is well positioned to replace lost revenues from its K-BOSSS and APS-5 contracts.
The company is operationally efficient, has a strong balance sheet and loads of free cash flow. Vectrus is well run, showing smart capital allocation of its free cash to pay down debt.
In terms of Vectrus’ valuation. The company is currently trading on a FCF/Price Yield of 15% (ttm), a FCF/EV Yield of 13% (ttm) and an Acquirer’s Multiple of 6.11, or 6.11 times Operating Earnings*. Add to this the company’s P/E of 9.68, a P/B of 2 and a P/S of 0.21 and Vectrus remains clearly in undervalued territory.
