{"id":94618,"date":"2016-08-22T09:25:59","date_gmt":"2016-08-22T13:25:59","guid":{"rendered":"http:\/\/countingpips.com\/?p=94618"},"modified":"2016-08-22T07:12:03","modified_gmt":"2016-08-22T11:12:03","slug":"orbital-atk-value-and-opportunity-from-this-defense-contractor","status":"publish","type":"post","link":"https:\/\/www.investmacro.com\/forex\/2016\/08\/orbital-atk-value-and-opportunity-from-this-defense-contractor\/","title":{"rendered":"Orbital ATK: Value AND Opportunity From This Defense Contractor"},"content":{"rendered":"
August 22, 2016<\/div>
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By WallStreetDaily.com<\/u><\/a> \"Orbital<\/p>\n

As Confederate General Robert E. Lee said, \u201cIt is well that war is so terrible, otherwise we should grow too fond of it.\u201d<\/p>\n

Thus conceding that war is terrible, does it make us a bunch of Milo Minderbinders if we invest in a military contractor?<\/p>\n

Are we indeed the spiritual(-ly bankrupt) offspring of Joseph Heller\u2019s mess officer\/war profiteer from Catch-22<\/em>, who\u2019s described by one critic as both a \u201cprophet of profit\u201d and the \u201cembodiment of evil\u201d?<\/p>\n

The debate over war profiteering has percolated in this country since the 1860s, when \u201cshoddy millionaires\u201d both North and South were subjected to \u201cscurrilous charges\u201d of making money over the dead bodies of brave soldiers.<\/p>\n

I don\u2019t begrudge you the moral high ground if in this particular ethical dilemma you steer clear of weapons stocks.<\/p>

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But what if we frame the debate in terms of \u201cdefense\u201d rather than war?<\/p>\n

(Though, granted, that may be a distinction without a difference in this age of American Empire and perpetual armed conflict, with a proven interventionist on her way to the White House.)<\/p>\n

And what if that military contractor also does a lot of work for civilian aerospace projects, public and private?<\/p>\n

These nuances, and a little self-awareness, make a question of pure amorality a little more complex.<\/p>\n

In the absence of clarity, I suggest we fall back on value and opportunity.<\/p>\n

Thinking as an investor, my priorities are to buy low, sell high, and build wealth for the long term.<\/p>\n

I\u2019ll let God sort everything else out.<\/p>\n

We first discussed Orbital ATK Inc.<\/strong> (OA<\/strong><\/a>) on August 15<\/strong><\/a>, with regard to its selection by NASA to participate in a contest to design prototype deep-space habitats for a planned mission to Mars.<\/p>\n

To reiterate, Orbital ATK is the result of the February 9, 2015, merger of Orbital Sciences Corp. and Alliant Techsystems.<\/p>\n

Through its Flight Systems, Defense Systems and Space Systems groups, Orbital researches, designs, develops, and manufactures rockets, rocket motors, satellites and spacecraft.<\/p>\n

With a market cap of $4.25 billion, Orbital shares are up about 14% since the merger, outperforming the Russell 2000 and the S&P 500 by 2.6% and 6.4%, respectively.<\/p>\n

As I noted last week, before the market opened on August 10, Orbital management announced that it would restate its fiscal 2015 financial results and delay the announcement of fiscal 2016 second-quarter earnings.<\/p>\n

That prompted a sell-off of nearly 25%.<\/p>\n

On August 9, the stock closed at $88.77, 6.5% below its 52-week high of $94.92. It gapped lower to $78.52 at the August 10 open and traded as low as $67.04.<\/p>\n

It\u2019s now trading around $73.<\/p>\n

That\u2019s one helluva correction \u2014 a crash, even.<\/p>\n

Is there some fundamental reason to justify this sell-off?<\/p>\n

Based on management\u2019s explanation for the restatement, my answer is no. And that means there\u2019s strong value and significant opportunity in Orbital shares.<\/p>\n

CFO Garrett Pierce explained the accounting errors during Orbital\u2019s preliminary second-quarter earnings conference call.<\/p>\n

According to Pierce, the problems relate to a contract awarded to predecessor Alliant Techsystems in 2012 to produce small-caliber ammunition for the U.S. Army and other military services and to operate and maintain the Lake City ammunition plant on behalf of the U.S. government.<\/p>\n

The fixed-price contract from 2012\u20132022 has a total value of approximately $2.3 billion. It currently generates $240\u2013250 million in annual revenue for Orbital \u2014 about 5% of the company\u2019s total sales.<\/p>\n

Explained Pierce, \u201cAs an earlier Army ammo contract was winding down, this new program moved into high-rate production in fiscal year 2015. In order to provide the best possible value to our military, the company had to price the new contract aggressively.\u201d<\/p>\n

Part of its aggressive approach included an effort to contain costs. But Orbital\u2019s Lake City operation \u201cwas unable to reduce the production cost far enough for the contract to be profitable.<\/p>\n

\u201cAt the same time,\u201d Pierce added, \u201cthe implementation of a new enterprise resource planning system in 2014 and other challenges obscured actual cost trends until our recent review.\u201d<\/p>\n

Orbital management forecasts that the associated accounting errors will result in a pretax operating loss of approximately $400 million and an after-tax loss of about $250 million over the 10-year life of the Lake City contract.<\/p>\n

The company will realize this loss in fiscal 2015, the first year of large-scale production under the contract.<\/p>\n

Management doesn\u2019t expect the adjustment to \u201cresult in material changes to [its] earnings guidance for the balance of 2016 or in future years.\u201d<\/p>\n

It will, however, reduce cash flow by about $25\u201330 million in 2016 and 2017 and by similar amounts out to 2022, when the contract expires.<\/p>\n

The bottom line? Based on the midpoints of management\u2019s guidance figures:<\/p>\n