Cubic Corporation (CUB, Financial) is primarily engaged in design, development, manufacturing, integration, and sustainment of high technology systems, products, and services for government and commercial customers. The company operates in three segments namely cubic transportation systems, cubic global defence systems and mission support services.
Year to date, Cubic Corporation has corrected by 20% and currently trades at $42 per share. This article discusses why this correction is a good long-term accumulation opportunity. In my opinion, this stock will unlock real value in the next 3-5 years. Therefore, a long-term investment horizon is important.
On Aug. 11, the Pentagon awarded a $20.9 billion ceiling value contract for 10 years and 25 companies will bid against each other for these contracts. Cubic Corporation is among the 25 companies. While the bidding will decide on contracts, the important point to note is that Cubic Corporation is among the shortlisted names and can potentially win big contracts in the next few years. The second important point to note is that Pentagon is awarding big contracts and I believe that this will continue as global geo-political worries are on a high. As of 1H15, Cubic Corporation had an order backlog of $575 million in the segment and I expect the backlog to swell in the coming years from above mentioned contract and from other contracts.
I mentioned the defence segment first for the likely growth in the coming years and the new contract. However, the company’s cubic transportation system segment has a robust order backlog of $1.9 billion and the segment has seen strong order inflow recently. The segment has also been awarded for forward thinking and innovation. As there is a focus towards making processes in the global transportation system easy, smooth and largely automated, the segment has strong growth prospects. The company has been awarded contracts in UK, Ireland and Australia among others and this shows that the penetration of this segment is global.
I am talking about the positives, but it’s important to mention that the company reported EPS of $2.59 for FY14. However, the EPS for FY15 is likely to be from $1.1 to $1.3 per share. Therefore, there is disappointment on that front, but that is already discounted by the stock. Further, the likely decline in EPS is primarily due to currency headwinds, ERP implementation cost, GAAP tax valuation allowance and increased funding for innovation. Through these initiatives, the company expects to increase margins by 200 to 250 basis points by 2018. Therefore, the near-term depression in EPS is not a concern.
Over the next few years, Cubic Corporation targets top-line growth of 10% and I believe that this is entirely possible considering the current order backlog, backlog growth prospects and inorganic growth. Cubic Corporation has made acquisitions on a consistent basis to build presence in other regions or to acquire new technology. I expect inorganic growth to continue.
Cubic Corporation reported negative operating cash flows for FY12 and FY13 primarily due to capitalized project costs. However, for FY14, the company reported positive operating cash flow of $115 million and an operating cash flow of $61 million for 1H15. Positive OCF allows the company to gain higher investment flexibility.
From a revenue visibility perspective, Cubic Corporation had a total order backlog of $3.1 billion as of 2Q15 and this implies revenue visibility of two years based on FY14 revenue. Stable revenue inflow in the coming years along with improving margins will take the stock higher. In addition, I see the company winning more orders from outside the US. For FY14, 54% of revenue was from the US, 21% from UK and 12% from Australia. I expect more the company to expand global presence, especially in the transportation systems segment.
Considering the healthy backlog, the prospects for margin expansion and strong top-line growth outlook, Cubic Corporation is a stock worth considering for the long-term. The stock has corrected in YTD15 and I see this as an opportunity to accumulate this growing company.
