Monday, May 14, 2018

A current AIM Program Small Cap Equity Holding: Mercury Systems, Inc. (MRCY) by: Matt Tully. "Sweet Mercury"


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Mercury Systems, Inc. (MRCY, $33.01): “Sweet Mercury”

By: Matt Tully, 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. (NASDAQ: MRCY) is a leading manufacturer of secure processing subsystems. MRCY specializes in embedded processing modules, radio frequency subsystems, microwave subsystems, and RF and microwave components. The company is headquartered in the United States, from which it derives over 90% of its revenue. I also want to note that MRCY ends its fiscal year in June.

• Due to missed earnings in 3Q2018, MRCY stock price has fallen 27%. The missed earnings was because of a shipping time problem affecting their top line revenue for 3Q.

• There are plenty of acquisitions in the pipeline for MRCY. With their acquisition past and their new capital structure, it can be assumed that they will continue with more acquisitions in the future. With 7% organic growth estimated for FY2018, these future acquisitions will allow them to achieve their long-term organic growth goal greater than 10%.

• There are five major trends that management thinks will shape the Defense industry. Three of these trends could have a major impact on MRCY’s future. These trends include the increase in Defense spending cycle, the Defense Procurement Reform, and the increasing innovative challenges that companies are facing.

Key points: Mercury systems recently missed 3Q revenue and EPS estimates due to a shift in $11 million from the 3Q into the 4Q. From what I can understand in the earnings call, essentially MRCY had a shipping time problem that required them to recognize the revenue in 4Q instead of 3Q. Despite missing earnings in 3Q, they have raised their full your guidance EPS.

Mercury has said that they want to stay well positioned to pursue larger acquisitions in the future. They are beginning to re-leverage their balance sheet to allow them to do this. Hopefully with these future acquisitions, MRCY can begin to consolidate a fragmented space.

According to a MRCY investor presentation, there are five major trends that are currently shaping the Defense industry. Three of these trends will have a very large impact on MRCY. The first one is that there is an increase in the Defense spending cycle due to rising interest rates and because of aging military platforms operations and maintenance costs rising. The second trend is the Defense Procurement Reform is changing the industry dynamics with firm-fixed-price contracts. The last notable trend is increasing innovative challenges. As a technology Defense company, MRCY needs to be leading the pack in innovation in order to succeed. They are trying to strengthen their innovation by having higher independent research & development than their peers.

Mercury had organic growth decline 6% year-over-year for the 3Q. As noted above, that was due in large part to the delayed shipment. Management has stated that they are expecting a large rebound in 4Q organic growth estimated to be approximately 17% year-over-year. The organic growth number is expected to be volatile from quarter to quarter due to a large number of acquisitions. However, management is happy with the success that MRCY is having in regards to integrating these acquisitions and realizing their synergies. Management will continue to target ~7% organic growth for fiscal year 2018 and hopes to achieve low double-digit organic growth for the long term.

What has the stock done lately?

Mercury Systems missed earnings by $0.02 for the 4Q2017. As a result of this, MRCY stock price has fallen 27% since April 23rd. In my opinion, a large part of that drop was due to an oversell from shareholders. Despite this immense dip in price, MRCY still has returned 40% since being held by the AIM Equity Fund.

Past Year Performance: MRCY has decreased 18.6% in value over the past year, but potentially could be trading at a bargain currently. Despite recent challenges in 3Q2018 (ending March 31st), guidance for the fiscal year still are 20% growth in both revenue and EBITDA. Prior to the decrease in stock price in April, MRCY was having a strong year. Mercury’s price had seen a steady increase from $40 to almost $53. On April 23rd, the stock price had increased by 11% from May 1st, 2017.

 Source: FactSet


My Takeaway

Despite missing earnings for 3Q, I still think Mercury’s fundamentals are still solid. The number one driver for this company when it was pitched in October 2016 was the positive outlook on defense spending. As management has stated, that is still the case today. I think that the massive decrease in stock price was partially an oversell, making this company a potential buy opportunity. With three acquisitions in 3Q2017 and bigger acquisitions in the pipeline, I like the position MRCY is in. However, I can understand if the AIM Program would like to sell this from the portfolio and take a 40% return on our investment.

Source: FactSet

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