Thursday, December 15, 2016

An AIM Equity Holding: Mercury Systems (MRC) by Nick Dykema. “Mercury Systems Scores Following Earnings Release and Trump Election"


“Mercury Takes Off Following First Quarter Earnings Release”
Mercury Systems, Inc. (MRCY, $30.15) - To Mercury and Beyond!
By: Nick Dykema, AIM Student at Marquette University


Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.

Summary

Mercury Systems, Inc. (NYSE: MRCY) provides prime contractors with secure processing subsystems to be used in the Department of Defense’s (DoD) critical defense and intelligence programs. Over half of MRCY’s revenues are derived from three prime defense contractors: Lockheed Martin (23%), Northrop Grumman (8%), and Raytheon (20%).

• MRCY’s stock price soared following the release of Q1 FY17 earnings that were highlighted by increased bookings and smooth integration of Microsemi’s Carve-Out business.

• Management has adjusted Q2 FY17 guidance to reflect a stronger second-half of the year compared to the first-half.

• The company increased FY17 guidance for revenue, GAAP income, and adjusted EBITDA.

• Mercury received a silver award for its Ensemble® LDS6526 server blade.

Key points:
Mercury’s acquired and organic businesses experienced better than anticipated success during Q1 FY17. There were many positives to the Company’s first quarter performance, which was highlighted by many of its performance metrics coming in at the high end of guidance. 

Mercury’s October revenues increased 50% YoY (8% organic growth), and management expects FY17 to post “solid” organic revenue growth as a whole. Compared to the same quarter of the previous year, GAAP income increased by 34% while adjusted EBITDA increased by 54%. Defense initiatives and programs, such Aegis, F-35, and Digital Electronic Warfare System, were the reason for Mercury’s boost in revenues.

Signs of the DoD’s plan to export more defense technology are surfacing within Mercury. The company has already booked Patriot foreign military sales to Japan, which is only the beginning of increased foreign sales. In addition, MRCY’s total bookings grew 41% during the quarter. Management expects sales to Lockheed Martin and Northrop Grumman to increase, because the two prime contractors have received production contracts for additional Surface Electronic Warfare Improvement Programs (SEWIP). The significant increase in bookings reaffirms the company’s expansion plans.

Mercury Systems has done an excellent job of integrating the acquired Carve-Out business from Microsemi. All of the Carve-Out business’ infrastructure and security has become integrated into Mercury’s existing platform, and MRCY is beginning to see the cost synergies, purchasing synergies, and improvements in manufacturing efficiencies materialize. Likewise, the company has discovered additional growth opportunities following the integration of Microsemi. Looking into the future, Mercury’s management reiterated their plans to pursue future acquisitions that can further develop their most important products (Radio Frequency and secure processing subsystems).

After looking at the company’s Q1 FY17 earnings call, specific financial results jump out. Adjusted earnings per share increased to $0.22 (high end of management’s guidance) from Q1 FY16’s adjusted earnings of $0.19. The company acknowledged capital expenditures will be far greater as MRCY begins construction of its new headquarters. 

Since acquisition integration will accelerate in the second-half of the year, management has revised their revenue and adjusted EBITDA guidance. In Q2, Mercury is forecasting revenue to be between $91 million and $95 million, adjusted EBITDA between $18 million and $21 million, and gross margin between 46% and 47%. 

Additionally, second quarter GAAP income is expected to be in the range of $2.7 million and $4.5 million, which would equate to earnings between $0.07 and $0.11 per share. The company has slightly increased their FY17 revenue guidance, which is now in the range of $370 million and $380 million. In addition, GAAP income is expected to be between $19.8 million and $22.4 million, while adjusted EBITDA will be in the range of $83 million to $87 million.

It should be noted Mercury Systems’ Ensemble® LDS6526 server blade was presented a silver award at the Military and Aerospace Electronics 2016 Innovators Awards Program. According to a press release on MRCY’s Investor Relations page, “This program recognizes the most innovative solutions in military and aerospace technology products and systems, as judged by a panel of senior third-party expert professionals.” The award further exemplifies Mercury’s commitment to research and development and pursuit of cutting edge technology within the defense industry.

What has the stock done lately?
Since being added to the AIM Equity Fund in mid-October 2016 at a price of $23.57, MRCY’s stock price has increased 27.9%. The company’s stock price has been climbing since the release of its Q1 FY17 earnings call. Even after the stock price’s initial earnings kick, Mercury has increased its value by 10.5% in November. 

Most of November’s success can be attributed to the outcome of the United States presidential election. It is believed president-elect Donald Trump will increase defense spending, which explains MRCY’s 18% jump in the week following his election.

Past Year Performance:
Over the last year, Mercury’s stock price has increased by 53.3%. Even though the stock has shown to be quite volatile following management’s release of earnings, the stock price has exhibited strong positive growth over the last year. Mercury’s 52 week high was $32.49, while its low was $15.67. Currently, the company’s stock price is trading near its highest level of the past year.

Source: FactSet

My Takeaway

I believe Mercury Systems is destined for success in the coming years. The company has had a few minor setbacks during the last three years, but has been able to increase its stock price by 334% since February 2013. Recently, MRCY does not seem to be showing signs of slowing down. 

The company continues to increase sales and dominate the secure processing subsystems segment of the defense technology industry. Due to a positive outlook for defense spending, Mercury is well-positioned to increase their future bookings and provide prime contractors and the Department of Defense with technology for their future defense and intelligence programs. 

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