By the end of 2022, I called Parsons (NYSE:PSN) not a very defensive stock, as investors priced in benefits (to the business) from increased political tensions, and related to that increased defense spending.
Sales momentum was improving, yet earnings growth felt a bit lackluster, which quite frankly made me cautious. The earnings growth materialized this year, as this observation, a growing backlog, bolt-on M&A, and renewed political tensions have rightfully sent shares higher here.
A Defense Play
Parsons provides technology-driven solutions for defense, intelligence and infrastructure markets, in order to help clients design, engineer, service and provide software to keep the world a smart, connected and safe place.
The business went public at $27 per share in 2019 when it generated nearly $4 billion in sales on which relatively low GAAP earnings of $120 million were reported, equal to $1.30 per share (albeit that adjusted earnings came in higher). Shares rallied to the mid-thirties in 2020 as (adjusted) earnings improved to a run rate around $2 per share.
In the end, 2020 sales fell a percent to $3.9 billion, with adjusted earnings coming in just shy of $2 per share, although that the company reported a huge backlog of around $8 billion. Despite the solid outlook, 2021 sales fell to just below $3.7 billion, with adjusted earnings down to $1.65 per share, as the 2022 outlook (which called for sales at $3.8 billion) was not too convincing.
To ignite some enthusiasm the company announced a $400 million deal to acquire Xator, as the conflict between Russia and Ukraine added another driver to the investment case as well. These developments led to shares ending 2022 around the $45 mark, with the market pricing in some anticipated tailwinds.
At the time the same company updated the 2022 sales guidance to more than $4.1 billion, although that earnings came in just shy of $2 per share, pushing up realistic earnings to a mid-twenty multiple. Moreover, the Xator deal pushed up leverage to 1.5 times, making me cautious to not get involved.
Caution – Until Now
Quite frankly, shares of Parsons have traded range bound between $40 and $50 per share. By August some good operating momentum and the conflict in the Middle-East provided another impetus to the shares, which trade near their highs here at $58 per share.
In February this year, Parsons posted a 15% increase in full year sales to $4.2 billion, with growth aided by the Xator deal. Adjusted earnings rose sixteen cents to $1.81 per share. The company guided for 2023 sales at a midpoint of $4.475 billion, with EBITDA seen around $385 million, up from $353 million in 2022. With net debt down to less than half a billion, leverage was not a concern here, as continued growth was seen this year.
In March, Parson announced the purchase of IPKeys Power Partners in a bolt-on deal valued at $43 million. First quarter results were strong, prompting the company to hike the full year guidance to $4.6 billion, with EBITDA seen at $395 million. Following the release of the second quarter results, the guidance was hiked again to $4.95 billion, with EBITDA now seen at $425 million, all as the backlog rose by 8% to nearly $9 billion.
On Fire
Adjusted earnings power is now firmly running over $2 per share after the release of the second quarter earnings report; in fact, it runs closer to $2.25 per share. Taking advantage of the momentum, Parsons announced a $200 million deal to acquire Sealing Technologies in August. The deal structure involves a $25 million earn-out provision, which means that the upfront cash tag comes in at $175 million, while the deal said to add $110 million in profitable sales.
With Parsons operating with 106 million shares outstanding which trade at $50, the company commanded a $5.8 billion valuation over the summer, at just over 1.2 times sales. Including the earn-out, Sealing is valued at 1.8 times sales, which looks a bit higher, but truth be told, the deal tag and revenue contribution (both at 2-3%) are rather limited. Moreover, net debt of around three quarters of a billion will mean that leverage will firmly remain in check at around 1.5 times.
Over the past month, the company announced four substantial contract awards at over $600 million, which trends far above the current revenue run rate, boding well for growth to continue.
A Final Word
With earnings firmly trending over $2.25 per share, the earnings multiple has fallen to 22 times, but this is ahead of the latest momentum and the contribution of Sealing, which likely adds a few pennies to earnings as well. Given all this, I understand why shares have run to the fifties and lower fifties, with momentum now being even strong on the back of the severe tensions, or better said war, in the Middle East.
It are these geopolitical developments, more bolt-on deals, strong contract wins which have driven the shares higher, for the right reasons. That said, some better days are being priced in as well. Moreover, potential for M&A (in the sense that lager parties might express an interest in Parsons) is pretty much limited, with M&A between larger defense players no longer tolerated here by regulators from antitrust perspectives.
Given all this, Parsons has been a decent stock and looks a fair play here, but I feel no need to urge getting involved here.
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